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Bank runs and investment decisions revisited

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  • Ennis, Huberto M.
  • Keister, Todd

Abstract

In this paper we extend the Cooper and Ross (1998) analysis of the optimal response of a competitive bank to the possibility of a bank run. If the probability of a run is small, the bank will offer a contract that admits a bank-run equilibrium. We show that, in this case, the bank will hold a quantity of liquid assets large enough to exactly meet withdrawal demand if a run does not occur; "excess" liquidity will not be held. This result allows us to determine how the possibility of a bank run affects the level of long-term investment chosen by a bank. We show that when the cost of liquidating investment early is high, the level of investment is decreasing in the probability of a run. However, when liquidation costs are smaller, the level of investment is actually increasing in the probability of a run.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Monetary Economics.

Volume (Year): 53 (2006)
Issue (Month): 2 (March)
Pages: 217-232

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Handle: RePEc:eee:moneco:v:53:y:2006:i:2:p:217-232

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Web page: http://www.elsevier.com/locate/inca/505566

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References

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  1. Russell Cooper & Thomas W. Ross, 1991. "Bank Runs: Liquidity and Incentives," NBER Working Papers 3921, National Bureau of Economic Research, Inc.
  2. Ennis, Huberto M. & Keister, Todd, 2005. "Government policy and the probability of coordination failures," European Economic Review, Elsevier, vol. 49(4), pages 939-973, May.
  3. Caprio, Gerard Jr. & Klingebiel, Daniela, 1996. "Bank insolvencies : cross-country experience," Policy Research Working Paper Series 1620, The World Bank.
  4. Alejandro Gaytan & Romain Ranciere, 2005. "Banks, Liquidity Crises and Economic Growth," DEGIT Conference Papers c010_040, DEGIT, Dynamics, Economic Growth, and International Trade.
  5. Ennis, Huberto M. & Keister, Todd, 2003. "Economic growth, liquidity, and bank runs," Journal of Economic Theory, Elsevier, vol. 109(2), pages 220-245, April.
  6. Champ, B. & Snith, B.D. & Williamson, D.S., 1991. "Currency Elasticity and Banking Panics: Theory and Evidence," RCER Working Papers 292, University of Rochester - Center for Economic Research (RCER).
  7. Cooper, Russell & Ross, Thomas W., 1998. "Bank runs: Liquidity costs and investment distortions," Journal of Monetary Economics, Elsevier, vol. 41(1), pages 27-38, February.
  8. Peck, James & Shell, Karl, 2001. "Equilibrium Bank Runs," Working Papers 01-10r, Cornell University, Center for Analytic Economics.
  9. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
  10. Neil Wallace, 1988. "Another attempt to explain an illiquid banking system: the Diamond and Dybvig model with sequential service taken seriously," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 3-16.
  11. Green, Edward J. & Lin, Ping, 2003. "Implementing efficient allocations in a model of financial intermediation," Journal of Economic Theory, Elsevier, vol. 109(1), pages 1-23, March.
  12. John H. Boyd & Pedro Gomis-Porqueras & Sungkyu Kwak & Bruce David Smith, 2014. "A User's Guide to Banking Crises," Annals of Economics and Finance, Society for AEF, vol. 15(2), pages 800-892, November.
  13. Freeman, Scott, 1988. "Banking as the Provision of Liquidity," The Journal of Business, University of Chicago Press, vol. 61(1), pages 45-64, January.
  14. Neil Wallace, 1990. "A banking model in which partial suspension is best," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 11-23.
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Citations

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Cited by:
  1. Friederike Niepmann & Tim Schmidt-Eisenlohr, 2011. "Bank Bailouts, International Linkages and Cooperation," Working Papers 170, Oesterreichische Nationalbank (Austrian Central Bank).
  2. Huberto M. Ennis & Todd Keister, 2007. "Commitment and equilibrium bank runs," Staff Reports 274, Federal Reserve Bank of New York.
  3. Huberto M. Ennis & Todd Keister, 2009. "Bank Runs and Institutions: The Perils of Intervention," American Economic Review, American Economic Association, vol. 99(4), pages 1588-1607, September.
  4. Gu, Chao, 2007. "Asymmetric Information and Bank Runs," Working Papers 07-14, Cornell University, Center for Analytic Economics.
  5. Hoerova, Marie, 2007. "Run-prone banking and asset markets," Working Paper Series 0845, European Central Bank.
  6. Garratt, Rod & Keister, Todd, 2009. "Bank runs as coordination failures: An experimental study," Journal of Economic Behavior & Organization, Elsevier, vol. 71(2), pages 300-317, August.
  7. Hoerova, Marie, 2005. "Financial Deepening and Bank Runs," Working Papers 05-07, Cornell University, Center for Analytic Economics.
  8. Douglas W. Diamond, 2007. "Banks and liquidity creation : a simple exposition of the Diamond-Dybvig model," Economic Quarterly, Federal Reserve Bank of Richmond, issue Spr, pages 189-200.
  9. Todd Keister & Huberto Ennis, 2012. "Optimal banking contracts and financial fragility," 2012 Meeting Papers 179, Society for Economic Dynamics.
  10. Huberto M. Ennis & Todd Keister, 2010. "On the fundamental reasons for bank fragility," Economic Quarterly, Federal Reserve Bank of Richmond, issue 1Q, pages 33-58.
  11. Antoine Martin, 2008. "Reconciling Bagehot with the Fed's response to September 11," Staff Reports 217, Federal Reserve Bank of New York.
  12. Wen-Yao Grace Wang & Paula Hernandez-Verme & Raymond A. K. Cox Author E-mail: rcox@unbc.ca, 2012. "Financial Fragility, Exchange-Rate Regimes, and Sudden Stops in a Small Open Economy," Ekonomi-tek - International Economics Journal, Turkish Economic Association, vol. 1(3), pages 25-54, September.

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