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Asymmetric Information and Bank Runs

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  • Gu, Chao

    (U of Missouri, Columbia)

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Abstract

It is known that sunspots can trigger panic-based bank runs and that the optimal banking contract can tolerate panic-based runs. The existing literature assumes that these sunspots are based on a publicly observed extrinsic randomizing device. In this paper, I extend the analysis of panic-based runs to include an asymmetric-information, extrinsic randomizing device. Depositors observe different, but correlated, signals on the stability of the bank. I find that if the signals that depositors obtain are highly correlated, there exists a correlated equilibrium for some demand deposit contracts. In this equilibrium, either a full bank run, or a partial bank run, or non bank run occurs depending on the realization of the signals. Computed examples indicate that in some economies, a demand-deposit contract that tolerates bank runs and partial bank runs is optimal; while in some other economies a run-proof contract is optimal.

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Paper provided by Cornell University, Center for Analytic Economics in its series Working Papers with number 07-14.

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Date of creation: Oct 2007
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Handle: RePEc:ecl:corcae:07-14

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  1. Gale, D. & Allen, F., 1991. "Limited Market Participation and Volatility of Asset Prices," Weiss Center Working Papers 14-91, Wharton School - Weiss Center for International Financial Research.
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  8. Gary Gorton, 1986. "Banking panics and business cycles," Working Papers 86-9, Federal Reserve Bank of Philadelphia.
  9. Itay Goldstein & Ady Pauzner, 2005. "Demand-Deposit Contracts and the Probability of Bank Runs," Journal of Finance, American Finance Association, vol. 60(3), pages 1293-1327, 06.
  10. Chao Gu, 2007. "Herding and Bank Runs," Working Papers 0716, Department of Economics, University of Missouri.
  11. Charles W. Calomiris & Gary Gorton, . "The Origins of Banking Panics: Models, Facts, and Bank Regulation," Rodney L. White Center for Financial Research Working Papers 11-90, Wharton School Rodney L. White Center for Financial Research.
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  17. Bryant, John, 1980. "A model of reserves, bank runs, and deposit insurance," Journal of Banking & Finance, Elsevier, vol. 4(4), pages 335-344, December.
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Cited by:
  1. Todd Keister & Huberto M. Ennis, 2007. "Commitment and Equilibrium Bank Runs," 2007 Meeting Papers 509, Society for Economic Dynamics.

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