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On sunspots, bank runs, and Glass–Steagall

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  • Karl Shell
  • Yu Zhang

Abstract

We analyze the pre‐deposit game in a two‐depositor banking model. The Glass–Steagall bank is assumed to be restricted to holding only liquid assets. Depositors tolerate a panic‐based run if its probability of occurrence s is small. How s affects the allocation of assets depends on the incentive compatibility constraint (ICC). When the ICC is not binding, the sunspot allocation is not a mere randomization over the run and non‐run outcomes under the so‐called “optimal contract.” We offer this paper as a contribution to both the literature on banking and financial fragility and also the broader literature on sunspot equilibrium.

Suggested Citation

  • Karl Shell & Yu Zhang, 2019. "On sunspots, bank runs, and Glass–Steagall," International Journal of Economic Theory, The International Society for Economic Theory, vol. 15(1), pages 13-25, March.
    • Handle: RePEc:bla:ijethy:v:15:y:2019:i:1:p:13-25
    DOI: 10.1111/ijet.12208
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    Cited by:

    1. James Peck & Abolfazi Setayesh, 2023. "Bank Runs and the Optimality of Limited Banking," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 47, pages 100-110, January.
    2. Shenglei Pei & Lijuan Ye & Wei Zhou, 2022. "Application of convolutional neural network under nonlinear excitation function in the construction of employee incentive and constraint model," International Journal of System Assurance Engineering and Management, Springer;The Society for Reliability, Engineering Quality and Operations Management (SREQOM),India, and Division of Operation and Maintenance, Lulea University of Technology, Sweden, vol. 13(3), pages 1142-1153, December.

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