Evolutionary Forces in a Banking System with Speculation and System Risk
AbstractFor an N players coordination games, Tanaka (2000) proved that the notion of N/2 stability defined by Schaffer (1988) is a necessary and sufficient condition for long run equilibrium in an evolutionary process with mutations (in the sense of Kandori, et. al. (1993)). We argue that the critical number in Schaffer's stability is not unique in every application, but can vary with variables determined before the coordination games. In our specific model, these variables are the portfolio choices of the banks. We derived a Z* stability condition for the long run equilibrium for the banking system, in which there is no speculative bank run. This critical number of players is a function of the size for risky investment, and varies with total risky investments when there are more than two banks. We use this framework to analyze the effect of speculative behavior on banks' risk taking and the phenomenon of system risk, calculating the probability when more than one bank fail together (system risk). Our specific results include: first, we propose a Z* stability condition, which is proved to be a necessary and sufficient condition for such a long run equilibrium in the sense of KMR. This critical number of Z* is a function of the total risky investment in the banking system. In the case with two banks, this value could vary across banks. Second, speculative behaviors do not frustrate single bank's risky taking, but rather, encourage the bank to maintain a high enough level of risky investment, to keep the system stay in the equilibrium of no run. This indicates that although the speculative run equilibrium will be eliminated in the long run, the probability of fundamental run will increase with the mere possibility of speculative behavior. It is well known that sufficiently large exogenous shocks can cause a crisis. For example, Allen and Gale (1998) describe a model in which financial crises are caused by exogenous asset-return shocks. Following a large (negative) shock to asset returns, banks are unable to meet their commitments and are forced to default and liquidate assets. Third, the single bank case does not necessarily apply to the case with multiple banks. Symmetric banks can take different level of risks, which induces a different in the probability of bank failures. The probability of joint failures increases, compare to the case without speculation, but the individual probability of bank failures do not necessarily increase.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Econometric Society in its series Econometric Society 2004 Far Eastern Meetings with number 692.
Date of creation: 11 Aug 2004
Date of revision:
Contact details of provider:
Phone: 1 212 998 3820
Fax: 1 212 995 4487
Web page: http://www.econometricsociety.org/pastmeetings.asp
More information through EDIRC
speculative run; evolution process; random mutations; portfolio management; system risk; equilibrium selection; long run stability;
Find related papers by JEL classification:
- C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
This paper has been announced in the following NEP Reports:
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Jorgen W. Weibull, 1997. "Evolutionary Game Theory," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262731215, June.
- Franklin Allen & Douglas Gale, 2003. "Financial Fragility, Liquidity and Asset Prices," Center for Financial Institutions Working Papers 01-37, Wharton School Center for Financial Institutions, University of Pennsylvania.
- Matsui Akihiko & Matsuyama Kiminori, 1995.
"An Approach to Equilibrium Selection,"
Journal of Economic Theory,
Elsevier, vol. 65(2), pages 415-434, April.
- Akihiko Matsui & Kiminori Matsuyama, 1990. "An Approach to Equilibrium Selection," Discussion Papers 970, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
- Akihiko Matsui & Kiminori Matsuyama, 1991. "An Approach to Equilibrium Selection," Discussion Papers 1065, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
- Matsui, A. & Matsuyama, K., 1991. "An Approach to Equilibrium Selection," Working Papers e-91-14, Hoover Institution, Stanford University.
- Matutes, Carmen & Vives, Xavier, 1995.
"Imperfect Competition, Risk Taking, and Regulation in Banking,"
CEPR Discussion Papers
1177, C.E.P.R. Discussion Papers.
- Matutes, Carmen & Vives, Xavier, 2000. "Imperfect competition, risk taking, and regulation in banking," European Economic Review, Elsevier, vol. 44(1), pages 1-34, January.
- Martin Summer, 2003.
"Banking Regulation and Systemic Risk,"
Open Economies Review,
Springer, vol. 14(1), pages 43-70, January.
- Ennis, Huberto M. & Keister, Todd, 2003.
"Economic growth, liquidity, and bank runs,"
Journal of Economic Theory,
Elsevier, vol. 109(2), pages 220-245, April.
- Hans Carlsson & Eric van Damme, 1993.
"Global Games and Equilibrium Selection,"
Levine's Working Paper Archive
122247000000001088, David K. Levine.
- Carlsson, H. & Damme, E.E.C. van, 1990. "Global games and equilibrium selection," Discussion Paper 1990-52, Tilburg University, Center for Economic Research.
- Carlsson, H. & Damme, E.E.C. van, 1993. "Global games and equilibrium selection," Open Access publications from Tilburg University urn:nbn:nl:ui:12-154416, Tilburg University.
- Carlsson, H. & Van Damme, E., 1990. "Global Games And Equilibrium Selection," Papers 9052, Tilburg - Center for Economic Research.
- Tanaka, Yasuhito, 2000. "A finite population ESS and a long run equilibrium in an n players coordination game," Mathematical Social Sciences, Elsevier, vol. 39(2), pages 195-206, March.
- Acharya, Viral V., 2009.
"A theory of systemic risk and design of prudential bank regulation,"
Journal of Financial Stability,
Elsevier, vol. 5(3), pages 224-255, September.
- Acharya, Viral V., 2009. "A Theory of Systemic Risk and Design of Prudential Bank Regulation," CEPR Discussion Papers 7164, C.E.P.R. Discussion Papers.
- Young, H Peyton, 1993. "The Evolution of Conventions," Econometrica, Econometric Society, vol. 61(1), pages 57-84, January.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Christopher F. Baum).
If references are entirely missing, you can add them using this form.