Electricity and Markets

The article shows that in a finite-trader version of the Diamond and Dybvig model (1983), the ex ante efficient allocation can be implemented as a unique equilibrium. This is so even in the presence of the sequential service constraint, as emphasized by Wallace (1988), whereby the bank must solve a sequence of maximization problems as depositors contact it at different times. A three-trader example with constant relative risk-aversion utility is used in order to illustrate clearly the requirements that the sequential service constraint imposes on implementation. The views expressed herein are those of the authors and not necessarily those of the Federal Reserve Bank of Minneapolis or the Federal Reserve System. History is replete with instances in which a seemingly healthy economy has plunged into difficulty, investors have become suddenly insistent on exercising contrac-tual options to mitigate their individual risks, and finan