This paper shows that bank deposit contracts can provide allocations superior to those of exchange markets, offering an explanation of how banks subject to runs can attract deposits. Investors face privately observed risks which lead to a demand for liquidity. Traditional demand deposit contracts which provide liquidity have multiple equilibria, one of which is a bank run. Bank runs in the model cause real economic damage, rather than simply reflecting other problems. Contracts which can prevent runs are studied, and the analysis shows that there are circumstances when government provision of deposit insurance can produce superior contracts.

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Bank Runs, Deposit Insurance, and Liquidity

This paper develops a theory of financial intermediation based on minimizing the cost of monitoring information which is useful for resolving incentive problems between borrowers and lenders. It presents a characterization of the costs of providing incentives for delegated monitoring by a financial intermediary. Diversification within an intermediary serves to reduce these costs, even in a risk neutral economy. The paper presents some more general analysis of the effect of diversification on resolving incentive problems. In the environment assumed in the model, debt contracts with costly bankruptcy are shown to be optimal. The analysis has implications for the portfolio structure and capital structure of intermediaries.

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Financial Intermediation and Delegated Monitoring

The author argues that the preponderance of theoretical reasoning and empirical evidence suggests a positive first order relationship between financial development and economic growth. There is evidence that the financial development level is a good predictor of future rates of economic growth, capital accumulation, and technological change. Moreover, cross-country, case-style, industry level and firm-level analysis document extensive periods when financial development crucially affects the speed and pattern of economic development. The author explains what the financial system does and how it affects, and is affected by, economic growth. Theory suggests that financial instruments, markets and institutions arise to mitigate the effects of information and transaction costs. A growing literature shows that differences in how well financial systems reduce information and transaction costs influence savings rates, investment decisions, technological innovation, and long-run growth rates. A less developed theoretical literature shows how changes in economic activity can influence financial systems. The author advocates a functional approach to understanding the role of financial systems in economic growth. This approach focuses on the ties between growth and the quality of the functions provided by the financial systems. The author discourages a narrow focus on one financial instrument, or a particular institution. Instead, the author addresses the more comprehensive question: What is the relationship between financial structure and the functioning of the financial system?

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Financial development and economic growth : views and agenda

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Convex Analysisの二,三の進展について

An informational cascade occurs when it is optimal for an individual, having observed the actions of those ahead of him, to follow the behavior of the preceding individual without regard to his own information. We argue that localized conformity of behavior and the fragility of mass behaviors can be explained by informational cascades.

https://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1405027_code2024.pdf?abstractid=1286306&mirid=1&type=2

A Theory of Fads, Fashion, Custom, and Cultural Change as Informational Cascades

An uninformed observer using the tools of mean variance and security market line analysis to measure the performance of a portfolio manager who has superior information is unlikely to be able to make any reliable inferences. While some positive results of a very limited nature are possible, e.g., when there is a riskless asset or when information is restricted to be "security specific," in general anything is possible. In particular, a manager with superior information can appear to the observer to be below or above the security market line and inside or outside of the mean-variance efficient frontier, and any combination of these is possible. MEAN-VARIANCE THEORY PREDICTS that if we plot expected returns against beta coefficients, all securities plot on a single line, known as the security market line (SML). Since fpi, the beta coefficient for security i, is interpreted as a measure of the riskiness of security i, the market line is a graphical representation of the linear relationship between risk and return. What are we to make of deviations from the SML, i.e., of securities or managed portfolios that do not plot on such a line? If we can retain our intuitive interpretation of fj as the riskiness of asset i and the market line as the appropriate expected return needed to "reward" agents taking on various degrees of risk, then vertical deviations from the market line represent abnormal returns that differ from what is merited. This paper and the companion piece, Dybvig and Ross [10], explore in detail the validity of this intuition and the question of what SML deviations really measure. The companion piece analyzes SML deviations caused by the choice of an inefficient market or reference portfolio. In this paper, we analyze SML deviations caused by superior performance based on superior information. The intuitive explanation of deviations from the SML has motivated many

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Differential Information and Performance Measurement Using a Security Market Line

The one-factor version of the Cox, Ingersoll, and Ross model of the term structure is estimated using monthly quotes on U.S. Treasury issues trading from 1952 through 1983. Using data from a single yield curve, it is possible to estimate implied short and long term zero coupon rates and the implied variance of changes in short rates. Analysis of residuals points to a probable neglected tax effect. THE TERM STRUCTURE of interest rates is important to economists because the relationship among the yields on default free securities that differ in their term to maturity reflects the information available to the market about the future course of events. The Expectations Hypothesis, the Liquidity Preference Hypothesis (Hicks [10]) and the Market Segmentation Hypothesis (Culbertson [6]) are theories of the term structure that predict little more than that the implied forward rate is either equal to or not equal to the expectation of future spot rates. Cox, Ingersoll and Ross [5] (CIR) model the term structure of interest rates in a competitive equilibrium context. Their model has elements in common with the earlier hypotheses of the term structure. However, the CIR model has a rich class of empirical implications, not only for the pricing of default free securities, but also for the pricing of bond options, callable bonds and other types of financial claims. This paper examines the extent to which the model (in its simplest one-factor form) is descriptive of the prices of U.S. Treasury Bills, Bonds and Notes traded from 1952 to 1983. Section I describes the model, and the parsimonious representation of bond prices which it implies. Section II describes the data and Section III outlines the preliminary results obtained by fitting the model to observed data. The final section outlines directions for future research.

https://www.jstor.org/stable/pdfplus/2328491.pdf

The Empirical Implications of the Cox, Ingersoll, Ross Theory of the Term Structure of Interest Rates

Two paradigms in the pricing of risky assets are the "complete markets" model of Arrow and Debreu and mean-variance pricing as embodied in the capital asset pricing model (CAPM). The former is primarily of theoretical interest. In fact, prior to the recent work of Banz and Miller (1978) and Breeden and Litzenberger (1978) there was little thought or hope of practical applications. On the other hand, the hegemony of the CAPM is due mostly to its apparent ease of applicability and, to a lesser extent, its empirical justification. In a competitive market with no taxes, transactions costs, or institutional constraints on portfolio holdings, the allocation of the available assets will be Pareto optimal. The end-of-period distribution of wealth (or the consumption goods), however, will typically be Pareto optimal only when there is available an Arrow-Debreu security for each contingency. Since, by definition, a Pareto superior reallocation is weakly preferred by all investors, a complete set of Arrow-Debreu markets should naturally arise provided they are not too costly to establish. The complete-markets model of Arrow and Debreu and the meanvariance capital asset pricing model (CAPM) are two paradigms of risky asset markets. This paper provides an integration of these two theories. We prove that the standard meanvariance separation theorem obtains in a complete market only if all investors have quadratic utility. In addition, the familiar CAPM pricing relation can hold for all assets in a complete market only if arbitrage opportunities exist. On the positive side, we show that the validity of this relation for the primary assets in a complete market is unaffected by the distribution of returns on the created financial assets.

Mean-Variance Theory in Complete Markets

A number of portfolio strategies followed by practitioners are dominated because they are incompletely diversified over time. The Payoff Distribution Pricing Model is used to compute the cost of following undiversified strategies. Simple numerical examples illustrate the technique, and computer-generated examples provide realistic estimates of the cost of some typical policies using reasonable parameter values. The cost can be substantial and should not be ignored by practitioners. A section on generalizations shows how to extend the analysis to term structure models and other general models of returns.(This abstract was borrowed from another version of this item.)

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Philip H. Dybvig

Papers

Bank Runs, Deposit Insurance, and Liquidity

Differential Information and Performance Measurement Using a Security Market Line

The Empirical Implications of the Cox, Ingersoll, Ross Theory of the Term Structure of Interest Rates

Mean-Variance Theory in Complete Markets

Inefficient Dynamic Portfolio Strategies or How to Throw Away a Million Dollars in the Stock Market