Should bank runs be prevented?
AbstractThis paper extends Diamond and Dybvig’s model [J. Political Economy 91 (1983) 401] to a framework in which bank assets are risky, there is aggregate uncertainty about the demand for liquidity in the population and some individuals receive a signal about bank asset quality. Others must then try to deduce from observed withdrawals whether an unfavorable signal was received by this group or whether liquidity needs happen to be high. In this environment, both information-induced and pure panic runs will occur. However, banks can prevent them by designing the deposit contract appropriately. It is shown that in some cases it is optimal for the bank to prevent runs but there are situations where the bank run allocation may be welfare superior.
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Bibliographic InfoPaper provided by Universidad Carlos III de Madrid in its series Open Access publications from Universidad Carlos III de Madrid with number info:hdl:10016/7582.
Length: 1002 p.
Date of creation: May 2003
Date of revision:
Publication status: Published in Journal of Banking & Finance (2003-05) v.Vol 27, p.977-1000
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Web page: http://www.uc3m.es
Bank runs; Deposit contracts; Liquidation costs; Optimal risk sharing; Suspension of convertibility;
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