In this paper we extend the Cooper and Ross (1998) analysis of the optimal response of a competitive bank to the possibility of a bank run. If 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 hold a quantity of liquid assets large enough to exactly meet withdrawal demand if a run does not occur; "excess" liquidity will not be held. This result allows us to determine how the possibility of a bank run affects the level of long-term 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 smaller, the level of investment is actually increasing in the probability of a run.
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Paper provided by Society for Economic Dynamics in its series 2004 Meeting Papers with number
180.
Length: Date of creation: 2004 Date of revision: Handle: RePEc:red:sed004:180
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Find related papers by JEL classification: G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Mortgages D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
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References listed on IDEAS 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.:
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)
Other versions:
Peck, James & Shell, Karl, 2001.
"Equilibrium Bank Runs,"
Working Papers
01-10r, Cornell University, Center for Analytic Economics.
[Downloadable!]
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