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Bank Runs and Investment Decisions Revisited

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  • Todd Keister
  • Huberto M. Ennis

Abstract

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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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2004 Meeting Papers with number 180.

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Date of creation: 2004
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Handle: RePEc:red:sed004:180

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Keywords: Bank runs;

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References

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  1. 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.
  2. Alejandro Gaytan & Romain Ranciere, 2004. "Banks, Liquidity Crises and Economic Growth," Econometric Society 2004 North American Summer Meetings 399, Econometric Society.
  3. Huberto M. Ennis & Todd Keister, 2003. "Economic growth, liquidity, and bank runs," Working Paper 03-01, Federal Reserve Bank of Richmond.
  4. 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.
  5. John H. Boyd & Pedro Gomis & Sungkyu Kwak & Bruce D. Smith, 2000. "A User's Guide to Banking Crises," Development Research Unit Working Paper Series archive-36, Monash University, Department of Economics.
  6. Champ, B. & Smith, B.D., 1991. "Currency Elasticity and Banking Panics: theory and Evidence," University of Western Ontario, The Centre for the Study of International Economic Relations Working Papers 9109, University of Western Ontario, The Centre for the Study of International Economic Relations.
  7. Russell Cooper & Thomas W. Ross, 1991. "Bank Runs: Liquidity and Incentives," NBER Working Papers 3921, National Bureau of Economic Research, Inc.
  8. Edward J. Green & Ping Lin, 1996. "Implementing efficient allocations in a model of financial intermediation," Working Papers 576, Federal Reserve Bank of Minneapolis.
  9. Caprio, Gerard Jr. & Klingebiel, Daniela, 1996. "Bank insolvencies : cross-country experience," Policy Research Working Paper Series 1620, The World Bank.
  10. 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.
  11. Peck, James & Shell, Karl, 2001. "Equilibrium Bank Runs," Working Papers 01-10r, Cornell University, Center for Analytic Economics.
  12. 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.
  13. Freeman, Scott, 1988. "Banking as the Provision of Liquidity," The Journal of Business, University of Chicago Press, vol. 61(1), pages 45-64, January.
  14. Neil Wallace, 1990. "A banking model in which partial suspension is best," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 11-23.
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Cited by:
  1. Hoerova, Marie, 2007. "Run-prone banking and asset markets," Working Paper Series 0845, European Central Bank.
  2. Huberto M. Ennis & Todd Keister, 2007. "Commitment and equilibrium bank runs," Staff Reports 274, Federal Reserve Bank of New York.
  3. Antoine Martin, 2008. "Reconciling Bagehot with the Fed's response to September 11," Staff Reports 217, Federal Reserve Bank of New York.
  4. Friederike Niepmann & Tim Schmidt-Eisenlohr, 2010. "Bank Bailouts, International Linkages and Cooperation," Working Papers 1016, Oxford University Centre for Business Taxation.
  5. 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.
  6. 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.
  7. Hoerova, Marie, 2005. "Financial Deepening and Bank Runs," Working Papers 05-07, Cornell University, Center for Analytic Economics.
  8. Gu, Chao, 2007. "Asymmetric Information and Bank Runs," Working Papers 07-14, Cornell University, Center for Analytic Economics.
  9. 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.
  10. 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.
  11. 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.
  12. Todd Keister & Huberto Ennis, 2012. "Optimal banking contracts and financial fragility," 2012 Meeting Papers 179, Society for Economic Dynamics.

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