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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. Bruce Champ & Bruce D. Smith & Stephen D. Williamson, 1996. "Currency Elasticity and Banking Panics: Theory and Evidence," Canadian Journal of Economics, Canadian Economics Association, vol. 29(4), pages 828-64, November.
  2. 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.
  3. Huberto M. Ennis & Todd Keister, 2003. "Government Policy and the Probability of Coordination Failures," Working Papers 0301, Centro de Investigacion Economica, ITAM.
  4. Edward J. Green, 1995. "Implementing Efficient Allocations in a Model of Financial Intermediation," Meeting papers 9506001, EconWPA.
  5. Freeman, Scott, 1988. "Banking as the Provision of Liquidity," The Journal of Business, University of Chicago Press, vol. 61(1), pages 45-64, January.
  6. Russell Cooper & Thomas Ross, 1991. "BANK RUNS: Liquidity and Incentives," Papers 0022, Boston University - Industry Studies Programme.
  7. John H. Boyd & Pedro Gomis & Sungkyu Kwak & Bruce D. Smith, 2000. "A User's Guide to Banking Crises," Monash Economics Working Papers archive-36, Monash University, Department of Economics.
  8. Alejandro Gaytan & Romain Ranciere, 2005. "Banks, Liquidity Crises and Economic Growth," DEGIT Conference Papers c010_040, DEGIT, Dynamics, Economic Growth, and International Trade.
  9. Neil Wallace, 1990. "A banking model in which partial suspension is best," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 11-23.
  10. Ennis, Huberto M. & Keister, Todd, 2003. "Economic growth, liquidity, and bank runs," Journal of Economic Theory, Elsevier, vol. 109(2), pages 220-245, April.
  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. 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.
  14. Caprio, Gerard Jr. & Klingebiel, Daniela, 1996. "Bank insolvencies : cross-country experience," Policy Research Working Paper Series 1620, The World Bank.
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Citations

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Cited by:
  1. 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.
  2. Friederike Niepmann & Tim Schmidt-Eisenlohr, 2013. "Bank Bailouts, International Linkages, and Cooperation," American Economic Journal: Economic Policy, American Economic Association, vol. 5(4), pages 270-305, November.
  3. Huberto M. Ennis & Todd Keister, 2007. "Commitment and equilibrium bank runs," Staff Reports 274, Federal Reserve Bank of New York.
  4. 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.
  5. 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.
  6. Todd Keister & Huberto Ennis, 2012. "Optimal banking contracts and financial fragility," 2012 Meeting Papers 179, Society for Economic Dynamics.
  7. 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.
  8. Antoine Martin, 2008. "Reconciling Bagehot with the Fed's response to September 11," Staff Reports 217, Federal Reserve Bank of New York.
  9. Gu, Chao, 2007. "Asymmetric Information and Bank Runs," Working Papers 07-14, Cornell University, Center for Analytic Economics.
  10. 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.
  11. Hoerova, Marie, 2007. "Run-prone banking and asset markets," Working Paper Series 0845, European Central Bank.
  12. Hoerova, Marie, 2005. "Financial Deepening and Bank Runs," Working Papers 05-07, Cornell University, Center for Analytic Economics.

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