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Bank runs and investment decisions revisited

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Author Info
Huberto M. Ennis
Todd Keister

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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. [Downloadable!] (restricted)
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  2. Russell Cooper & Thomas W. Ross, 1991. "Bank Runs: Liquidity and Incentives," NBER Working Papers 3921, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  3. Huberto M. Ennis & Todd Keister, 2003. "Government Policy and the Probability of Coordination Failures," Working Papers 0301, Centro de Investigacion Economica, ITAM. [Downloadable!]
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  4. 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. [Downloadable!]
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  5. 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. [Downloadable!] (restricted)
  6. Alejandro Gaytan & Romain Ranciere, 2004. "Banks, Liquidity Crises and Economic Growth," Econometric Society 2004 North American Summer Meetings 399, Econometric Society. [Downloadable!]
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  7. James Peck & Karl Shell, 2003. "Equilibrium Bank Runs," Journal of Political Economy, University of Chicago Press, vol. 111(1), pages 103-123, February. [Downloadable!] (restricted)
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Cited by:
(explanations, 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.)

  1. Antoine Martin, 2008. "Reconciling Bagehot with the Fed's response to September 11," Staff Reports 217, Federal Reserve Bank of New York. [Downloadable!]
  2. Huberto M. Ennis & Todd Keister, 2007. "Bank runs and institutions : the perils of intervention," Working Paper 07-02, Federal Reserve Bank of Richmond. [Downloadable!]
  3. Huberto M. Ennis & Todd Keister, 2007. "Commitment and equilibrium bank runs," Staff Reports 274, Federal Reserve Bank of New York. [Downloadable!]
  4. 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. [Downloadable!]
  5. Marie Hoerova, 2007. "Run-prone banking and asset markets," Working Paper Series 845, European Central Bank. [Downloadable!]
  6. Chao Gu, 2007. "Asymmetric Information and Bank Runs," Working Papers 0721, Department of Economics, University of Missouri. [Downloadable!]
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