Suspension of Convertibility versus Deposit Insurance: A Welfare Comparison

Abstract

This paper introduces risk-averse preferences in Chari and Jagannathan (1988). A first motivation for this extension is to give a positive role for a financial intermediary in the economy, who offers risk-sharing contracts to liquidity seeking individuals. In this framework, both informationinduced an pure panic runs will occur. The second motivation is to complete Chari and Jagannathan's welfare analysis by comparing suspension of convertibility and deposit insurance, given their relative benefits and costs (of randomization in meeting liquidity needs or deadweight taxation). It is shown that the choice between the two contracts depends on the level of risk aversion, the intertemporal discount factor and the attributes about the underlying technology.