ABSTRACT This paper seeks to explain the combination of explicit and implicit pricing for deposit insurance employed by the FDIC. Essentially, the FDIC sells two products—insurance and regulation. To span the product space, it must and does set two prices. We argue that the need to establish regulatory disincentives to bank risk‐taking is the heart of the controversy over the adequacy of bank capital and that the ability to close risky banks before exhausting their charter value (i.e., the value of their right to continue in business) stands at the center of these disincentives and in front of the FDIC's insurance reserves.

David A. Pierce, Darrel W. Parke, William P. Cleveland, Agustin Maravall, Uncertainty in the Monetary Aggregates: Sources, Measurement and Policy Effects, The Journal of Finance, Vol. 36, No. 2, Papers and Proceedings of the Thirty Ninth Annual Meeting American Finance Association, Denver, September 5-7, 1980 (May, 1981), pp. 507-515

By considering investor order placement strategy, this paper demonstrates that transaction costs cause bid-ask spreads to be an equilibrium property of asset markets. With transaction costs, the probability of a limit order executing does not go to unity as the order is placed infinitesimally close to a counterpart market quote; thus, with certainty of execution at the counterpart market quote, a "gravitational pull" is generated that keeps counterpart quotes from being placed infinitesimally close to each other. An equilibrium spread is defined and its size linked to market thinness; implications are noted for the design of a trading system.