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Equilibrium Bank Runs

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  • Peck, James

    (Ohio State U)

  • Shell, Karl

    (Cornell U)

Abstract

We analyze a banking system in which the class of feasible deposit contracts, or mechanisms, is broad. The mechanisms must satisfy a sequential service constraint, but partial or full suspension of convertibility is allowed. Consumers must be willing to deposit, ex ante. We show, by examples, that under the so-called "optimal contract," the post-deposit game can have a run equilibrium. Given a "propensity" to run, triggered by sunspots, the optimal contract for the full pre-deposit game can be consistent with runs that occur with positive probability. Thus, the Diamond-Dybvig framework can explain bank runs, as emerging in equilibrium under the optimal deposit contract.

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Bibliographic Info

Paper provided by Cornell University, Center for Analytic Economics in its series Working Papers with number 01-10r.

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Date of creation: Jun 2001
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Handle: RePEc:ecl:corcae:01-10r

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