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On the Existence of Equilibrium Bank Runs in a Diamond-Dybvig Environment

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  • Carmona, Guilherme

Abstract

In a version of the Diamond and Dybvig [6] model with aggregate uncertainty, we show that there exists an equilibrium with the following properties: all consumers deposit at the bank, all patient consumers wait for the last period to withdraw, and the bank fails with strictly positive probability. Furthermore, we show that the probability of a bank failure remains bounded away from zero as the number of consumers increases. We interpret such an equilibrium as reflecting a bank run, defined as an episode in which a large number of people withdraw their deposits from a bank, forcing it to fail. Our results show that we can have equilibrium bank runs with consumers poorly informed about the true state of nature, a sequential service constraint, an infinite marginal utility of consumption at zero, and without consumers panic and sunspots. We therefore think that aggregate risk in Diamond-Dybvig-like environments can be an important element to explain bank runs.

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Bibliographic Info

Paper provided by Universidade Nova de Lisboa, Faculdade de Economia in its series FEUNL Working Paper Series with number wp448.

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Length: 32 pages
Date of creation: 2004
Date of revision:
Handle: RePEc:unl:unlfep:wp448

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  1. Edward J. Green & Ping Lin, 2000. "Diamond and Dybvig's classic theory of financial intermediation : what's missing?," Quarterly Review, Federal Reserve Bank of Minneapolis, Federal Reserve Bank of Minneapolis, issue Win, pages 3-13.
  2. 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, Federal Reserve Bank of Minneapolis, issue Fall, pages 3-16.
  3. Edward J. Green & Ping Lin, 1996. "Implementing efficient allocations in a model of financial intermediation," Working Papers, Federal Reserve Bank of Minneapolis 576, Federal Reserve Bank of Minneapolis.
  4. Franklin Allen & Douglas Gale, 1998. "Optimal Financial Crises," Journal of Finance, American Finance Association, American Finance Association, vol. 53(4), pages 1245-1284, 08.
  5. Neil Wallace, 1990. "A banking model in which partial suspension is best," Quarterly Review, Federal Reserve Bank of Minneapolis, Federal Reserve Bank of Minneapolis, issue Fall, pages 11-23.
  6. Carmen M. Reinhart & Graciela L. Kaminsky, 1999. "The Twin Crises: The Causes of Banking and Balance-of-Payments Problems," American Economic Review, American Economic Association, American Economic Association, vol. 89(3), pages 473-500, June.
  7. Ennis, Huberto M. & Keister, Todd, 2003. "Economic growth, liquidity, and bank runs," Journal of Economic Theory, Elsevier, Elsevier, vol. 109(2), pages 220-245, April.
  8. Hildenbrand, Werner, 1971. "Random preferences and equilibrium analysis," Journal of Economic Theory, Elsevier, Elsevier, vol. 3(4), pages 414-429, December.
  9. Gorton, Gary, 1988. "Banking Panics and Business Cycles," Oxford Economic Papers, Oxford University Press, vol. 40(4), pages 751-81, December.
  10. Bernardino Adao & Ted Temzelides, 1998. "Sequential Equilibrium and Competition in a Diamond-Dybvig Banking Model," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 1(4), pages 859-877, October.
  11. Barlo, Mehmet & Carmona, Guilherme, 2011. "Strategic behavior in non-atomic games," MPRA Paper 35549, University Library of Munich, Germany.
  12. Karl Shell & James Peck, 2004. "Bank Portfolio Restrictions and Equilibrium Bank Runs," 2004 Meeting Papers, Society for Economic Dynamics 359, Society for Economic Dynamics.
  13. Bernadino Adao & Theodosios Temzelides, 1995. "Beliefs, competition, and bank runs," Working Papers 95-26, Federal Reserve Bank of Philadelphia.
  14. Carmona, Guilherme, 2004. "Nash and Limit Equilibria of Games with a Continuum of Players," FEUNL Working Paper Series, Universidade Nova de Lisboa, Faculdade de Economia wp442, Universidade Nova de Lisboa, Faculdade de Economia.
  15. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 91(3), pages 401-19, June.
  16. James Peck & Karl Shell, 2003. "Equilibrium Bank Runs," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 111(1), pages 103-123, February.
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Cited by:
  1. Ngalawa, Harold & Tchana Tchana, Fulbert & Viegi, Nicola, 2011. "Banking Instability and Deposit Insurance: The Role of Moral Hazard," MPRA Paper 31329, University Library of Munich, Germany.

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