Modeling the Legend, or, the Trouble with Diamond and Dybvig: Part II SHARE
[This is the last half of a two-part critique of Douglas Diamond and Philip Dybvig s highly influential paper purporting to show that fractional reserve banking systems are inherently unstable. Part I can be found here.
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Sauce for the Goose…
Half a century after the fact, the aggregate uncertainty version of the Diamond-Dybvig model appeared at long last to offer solid proof of the inherent instability of ordinary banks, together with an equally solid foundation for government deposit insurance. But no sooner had the inspectors started poking their flashlights around that supposedly solid structure than its serious weaknesses became evident.