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Herd Behavior, Bank Runs and Information Disclosure

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Author Info
Yorulmazer, Tanju

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Abstract

I develop a dynamic model of bank runs that allows me to study important phenomena such as the role of information externalities and herd behavior of depositors as a source of bank runs. I show that eliminating bank runs completely, even they can be generated by herd behavior of depositors, has costs. Furthermore, a deposit contract that allows for runs can achieve higher levels of depositor welfare than a contract that completely eliminates them. Since early liquidation of bank's assets is costly, a central bank that acts as a lender of last resort alleviates some of the costs associated with bank runs. Yet it cannot prevent runs on healthy banks in the absence of perfect information about the bank's asset quality. In those cases, a deposit contract, even with liquidity support from the central bank, cannot achieve the first-best efficient outcome. As a policy measure, any efforts to give market discipline a stronger role in achieving financial stability should be accompanied by transparency and disclosure of information on banks’ soundness and management of the crisis.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 9513.

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Date of creation: 21 May 2003
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Handle: RePEc:pra:mprapa:9513

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Find related papers by JEL classification:
D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information
G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Mortgages

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  1. Chamley, Christophe & Gale, Douglas, 1994. "Information Revelation and Strategic Delay in a Model of Investment," Econometrica, Econometric Society, vol. 62(5), pages 1065-85, September. [Downloadable!] (restricted)
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  2. Charles Enoch & Anne Marie Gulde & Carl-Johan Lindgren & Marc Quintyn & Leslie Teo & Tomás J. T. Baliño, 2000. "Financial Sector Crisis and Restructuring:Lessons from Asia," IMF Occasional Papers 188, International Monetary Fund. [Downloadable!]
  3. Zvika NEEMAN & Gerhard O. OROSEL, 1997. "Herding and the Winner's Curse in Markets with Sequential Bids," Vienna Economics Papers vie9711, University of Vienna, Department of Economics.
    Other versions:
  4. Rochet, Jean Charles & Vives, Xavier, 2002. "Coordination Failures and the Lender of Last Resort: Was Bagehot Right After All?," CEPR Discussion Papers 3233, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  5. Bikhchandani, Sushil & Hirshleifer, David & Welch, Ivo, 1992. "A Theory of Fads, Fashion, Custom, and Cultural Change in Informational Cascades," Journal of Political Economy, University of Chicago Press, vol. 100(5), pages 992-1026, October. [Downloadable!] (restricted)
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  7. Postlewaite, Andrew & Vives, Xavier, 1987. "Bank Runs as an Equilibrium Phenomenon," Journal of Political Economy, University of Chicago Press, vol. 95(3), pages 485-91, June. [Downloadable!] (restricted)
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  13. Paul Hoffman & Anthony M. Santomero, 1998. "Problem Bank Resolution: Evaluating the Options," Center for Financial Institutions Working Papers 98-05, Wharton School Center for Financial Institutions, University of Pennsylvania. [Downloadable!]
  14. Gary Gorton & Lixin Huang, 2002. "Banking Panics and the Origin of Central Banking," NBER Working Papers 9137, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  16. Bhattacharya, Sudipto & Boot, Arnoud W A & Thakor, Anjan V, 1998. "The Economics of Bank Regulation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 30(4), pages 745-70, November.
    Other versions:
  17. 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. [Downloadable!]
  18. Prati, A. & Schinasi, G.J., 1999. "Financial Stability in European Economic and Monetary Union," Princeton Studies in International Economics 86, International Economics Section, Departement of Economics Princeton University,.
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