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

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  • Guilherme Carmona

    (Universidade Nova de Lisboa)

Abstract

In a version of the Diamond and Dybvig (1983) 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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File URL: http://128.118.178.162/eps/fin/papers/0404/0404009.pdf
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Bibliographic Info

Paper provided by EconWPA in its series Finance with number 0404009.

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Length: 52 pages
Date of creation: 20 Apr 2004
Date of revision:
Handle: RePEc:wpa:wuwpfi:0404009

Note: Type of Document - pdf; pages: 52
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Web page: http://128.118.178.162

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Keywords: Bank runs; aggregate uncertainty;

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References

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  1. Guilherme Carmona, 2003. "Nash and Limit Equilibria of Games with a Continuum of Players," Game Theory and Information 0311004, EconWPA.
  2. 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.
  3. 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.
  4. 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.
  5. Edward J. Green, 1995. "Implementing Efficient Allocations in a Model of Financial Intermediation," Meeting papers 9506001, EconWPA.
  6. Peck, James & Shell, Karl, 2001. "Equilibrium Bank Runs," Working Papers 01-10r, Cornell University, Center for Analytic Economics.
  7. Neil Wallace, 1990. "A banking model in which partial suspension is best," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 11-23.
  8. Hildenbrand, Werner, 1971. "Random preferences and equilibrium analysis," Journal of Economic Theory, Elsevier, vol. 3(4), pages 414-429, December.
  9. Franklin Allen & Douglas Gale, 1976. "Optimal Financial Crises," Center for Financial Institutions Working Papers 97-01, Wharton School Center for Financial Institutions, University of Pennsylvania.
  10. Barlo, Mehmet & Carmona, Guilherme, 2011. "Strategic behavior in non-atomic games," MPRA Paper 35549, University Library of Munich, Germany.
  11. Gorton, Gary, 1988. "Banking Panics and Business Cycles," Oxford Economic Papers, Oxford University Press, vol. 40(4), pages 751-81, December.
  12. Karl Shell & James Peck, 2004. "Bank Portfolio Restrictions and Equilibrium Bank Runs," 2004 Meeting Papers 359, Society for Economic Dynamics.
  13. 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.
  14. Huberto M. Ennis & Todd Keister, 2003. "Economic growth, liquidity, and bank runs," Working Paper 03-01, Federal Reserve Bank of Richmond.
  15. Bernadino Adao & Theodosios Temzelides, 1995. "Beliefs, competition, and bank runs," Working Papers 95-26, Federal Reserve Bank of Philadelphia.
  16. 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.
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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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