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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. James Peck & Karl Shell, 2003. "Bank Portfolio Restrictions and Equilibrium Bank Runs," Levine's Bibliography 666156000000000077, UCLA Department of Economics.
  2. Franklin Allen & Douglas Gale, 1998. "Optimal Financial Crises," Journal of Finance, American Finance Association, vol. 53(4), pages 1245-1284, 08.
  3. Ennis, Huberto M. & Keister, Todd, 2003. "Economic growth, liquidity, and bank runs," Journal of Economic Theory, Elsevier, vol. 109(2), pages 220-245, April.
  4. Edward J. Green & Ping Lin, 1996. "Implementing efficient allocations in a model of financial intermediation," Working Papers 576, Federal Reserve Bank of Minneapolis.
  5. Carmona, Guilherme, 2004. "Nash and Limit Equilibria of Games with a Continuum of Players," FEUNL Working Paper Series wp442, Universidade Nova de Lisboa, Faculdade de Economia.
  6. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
  7. Gorton, Gary, 1988. "Banking Panics and Business Cycles," Oxford Economic Papers, Oxford University Press, vol. 40(4), pages 751-81, December.
  8. 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.
  9. 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.
  10. Reinhart, Carmen & Kaminsky, Graciela, 1999. "The twin crises: The causes of banking and balance of payments problems," MPRA Paper 14081, University Library of Munich, Germany.
  11. 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, issue Win, pages 3-13.
  12. James Peck & Karl Shell, 2003. "Equilibrium Bank Runs," Journal of Political Economy, University of Chicago Press, vol. 111(1), pages 103-123, February.
  13. Hildenbrand, Werner, 1971. "Random preferences and equilibrium analysis," Journal of Economic Theory, Elsevier, vol. 3(4), pages 414-429, December.
  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.
  15. Barlo, Mehmet & Carmona, Guilherme, 2011. "Strategic behavior in non-atomic games," MPRA Paper 35549, University Library of Munich, Germany.
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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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