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Bank runs and investment decisions revisited

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  • Huberto M. Ennis
  • Todd Keister

Abstract

We examine how the possibility of a bank run affects the deposit contract offered and the investment decisions made by a competitive bank. Cooper and Ross (1998) have shown that when 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 chose to hold an amount of liquid reserves exactly equal to what withdrawal demand will be if a run does not occur. In other words, precautionary or "excess" liquidity will not be held. This result allows us to determine how the possibility of a bank run affects the level of illiquid 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 moderate, the level of investment is actually increasing in the probability of a run.

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Paper provided by Federal Reserve Bank of Richmond in its series Working Paper with number 04-03.

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Date of creation: 2004
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Handle: RePEc:fip:fedrwp:04-03

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  1. Ennis, Huberto M. & Keister, Todd, 2003. "Economic growth, liquidity, and bank runs," Journal of Economic Theory, Elsevier, vol. 109(2), pages 220-245, April.
  2. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June.
  3. 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.
  4. Alejandro Gaytan & Romain Ranciere, 2004. "Banks, Liquidity Crises and Economic Growth," Econometric Society 2004 North American Summer Meetings 399, Econometric Society.
  5. Neil Wallace, 1990. "A banking model in which partial suspension is best," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 11-23.
  6. Russell Cooper & Thomas Ross, 1991. "BANK RUNS: Liquidity and Incentives," Papers 0022, Boston University - Industry Studies Programme.
  7. 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.
  8. 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.
  9. James Peck & Karl Shell, 2003. "Equilibrium Bank Runs," Journal of Political Economy, University of Chicago Press, vol. 111(1), pages 103-123, February.
  10. 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).
  11. Caprio, Gerard Jr. & Klingebiel, Daniela, 1996. "Bank insolvencies : cross-country experience," Policy Research Working Paper Series 1620, The World Bank.
  12. Freeman, Scott, 1988. "Banking as the Provision of Liquidity," The Journal of Business, University of Chicago Press, vol. 61(1), pages 45-64, January.
  13. 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.
  14. 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.
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Cited by:
  1. Gu, Chao, 2007. "Asymmetric Information and Bank Runs," Working Papers 07-14, Cornell University, Center for Analytic Economics.
  2. Hoerova, Marie, 2007. "Run-prone banking and asset markets," Working Paper Series 0845, European Central Bank.
  3. Todd Keister & Huberto Ennis, 2012. "Optimal banking contracts and financial fragility," 2012 Meeting Papers 179, Society for Economic Dynamics.
  4. Antoine Martin, 2008. "Reconciling Bagehot with the Fed's response to September 11," Staff Reports 217, Federal Reserve Bank of New York.
  5. 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.
  6. Friederike Niepmann & Tim Schmidt-Eisenlohr, 2010. "Bank Bailouts, International Linkages and Cooperation," Working Papers 1016, Oxford University Centre for Business Taxation.
  7. 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.
  8. Huberto M. Ennis & Todd Keister, 2007. "Commitment and equilibrium bank runs," Staff Reports 274, Federal Reserve Bank of New York.
  9. Hoerova, Marie, 2005. "Financial Deepening and Bank Runs," Working Papers 05-07, Cornell University, Center for Analytic Economics.
  10. 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.
  11. 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.
  12. 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.

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