IDEAS home Printed from https://ideas.repec.org/a/eee/ecofin/v46y2018icp89-102.html
   My bibliography  Save this article

Liquidity, bank runs, and fire sales under local thinking

Author

Listed:
  • Park, Hyun Woong
  • Bernardin, Thomas

Abstract

We examine the implications on banking crises when markets are populated by agents that neglect tail risks and form expectations conditioned on a favorable subset of possible states of the economy. We find that optimal bank liquidity is lower than would be the case under rational expectations, and, consequently, the banking system is more vulnerable to adverse shocks, which lead to bank runs. Asset pledgeability of surviving banks is also affected so that their capacity to raise external funds for purchasing assets of distressed banks is weakened. Further, we examine the case when asset returns are correlated through securitization. In this case adverse shocks are felt uniformly across the banking sector and banks that survive with the help of a public liquidity backstop will become risk-averse and reluctant to purchase distressed assets. Finally, we explore a government funded asset purchase program, that is implemented with an asset price target.

Suggested Citation

  • Park, Hyun Woong & Bernardin, Thomas, 2018. "Liquidity, bank runs, and fire sales under local thinking," The North American Journal of Economics and Finance, Elsevier, vol. 46(C), pages 89-102.
  • Handle: RePEc:eee:ecofin:v:46:y:2018:i:c:p:89-102
    DOI: 10.1016/j.najef.2018.04.001
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S1062940817303133
    Download Restriction: Full text for ScienceDirect subscribers only

    File URL: https://libkey.io/10.1016/j.najef.2018.04.001?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Williamson, Oliver E, 1988. " Corporate Finance and Corporate Governance," Journal of Finance, American Finance Association, vol. 43(3), pages 567-591, July.
    2. W. Scott Frame & Andreas Fuster & Joseph Tracy & James Vickery, 2015. "The Rescue of Fannie Mae and Freddie Mac," Journal of Economic Perspectives, American Economic Association, vol. 29(2), pages 25-52, Spring.
    3. Jean-Charles Rochet & Xavier Vives, 2004. "Coordination Failures and the Lender of Last Resort: Was Bagehot Right After All?," Journal of the European Economic Association, MIT Press, vol. 2(6), pages 1116-1147, December.
    4. Shleifer, Andrei & Vishny, Robert W, 1992. "Liquidation Values and Debt Capacity: A Market Equilibrium Approach," Journal of Finance, American Finance Association, vol. 47(4), pages 1343-1366, September.
    5. Bengt Holmström & Jean Tirole, 2001. "LAPM: A Liquidity‐Based Asset Pricing Model," Journal of Finance, American Finance Association, vol. 56(5), pages 1837-1867, October.
    6. Daniel Covitz & Nellie Liang & Gustavo A. Suarez, 2013. "The Evolution of a Financial Crisis: Collapse of the Asset-Backed Commercial Paper Market," Journal of Finance, American Finance Association, vol. 68(3), pages 815-848, June.
    7. Franklin Allen & Douglas Gale, 2004. "Financial Intermediaries and Markets," Econometrica, Econometric Society, vol. 72(4), pages 1023-1061, July.
    8. Bengt Holmstrom & Jean Tirole, 1998. "Private and Public Supply of Liquidity," Journal of Political Economy, University of Chicago Press, vol. 106(1), pages 1-40, February.
    9. Viral V. Acharya & Ouarda Merrouche, 2013. "Precautionary Hoarding of Liquidity and Interbank Markets: Evidence from the Subprime Crisis," Review of Finance, European Finance Association, vol. 17(1), pages 107-160.
    10. Troy Davig & Michal Kowalik & Charles S. Morris & Kristen Regehr, 2015. "Bank consolidation and merger activity following the crisis," Economic Review, Federal Reserve Bank of Kansas City, issue Q I, pages 31-49.
    11. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, vol. 24(Win), pages 14-23.
    12. Jacklin, Charles J & Bhattacharya, Sudipto, 1988. "Distinguishing Panics and Information-Based Bank Runs: Welfare and Policy Implications," Journal of Political Economy, University of Chicago Press, vol. 96(3), pages 568-592, June.
    13. Andrei Shleifer & Robert Vishny, 2011. "Fire Sales in Finance and Macroeconomics," Journal of Economic Perspectives, American Economic Association, vol. 25(1), pages 29-48, Winter.
    14. Nicola Gennaioli & Andrei Shleifer, 2010. "What Comes to Mind," The Quarterly Journal of Economics, Oxford University Press, vol. 125(4), pages 1399-1433.
    15. Lawrence Schmidt & Allan Timmermann & Russ Wermers, 2016. "Runs on Money Market Mutual Funds," American Economic Review, American Economic Association, vol. 106(9), pages 2625-2657, September.
    16. Gennaioli, Nicola & Shleifer, Andrei & Vishny, Robert, 2012. "Neglected risks, financial innovation, and financial fragility," Journal of Financial Economics, Elsevier, vol. 104(3), pages 452-468.
    17. Gorton, Gary & Metrick, Andrew, 2012. "Securitized banking and the run on repo," Journal of Financial Economics, Elsevier, vol. 104(3), pages 425-451.
    18. Hyman P. Minsky, 1992. "The Financial Instability Hypothesis," Economics Working Paper Archive wp_74, Levy Economics Institute.
    19. Chari, V V & Jagannathan, Ravi, 1988. " Banking Panics, Information, and Rational Expectations Equilibrium," Journal of Finance, American Finance Association, vol. 43(3), pages 749-761, July.
    20. Viral V. Acharya & Hyun Song Shin & Tanju Yorulmazer, 2013. "A Theory of Arbitrage Capital," Review of Corporate Finance Studies, Oxford University Press, vol. 2(1), pages 62-97.
    21. Sudipto Bhattacharya & Charles A.E. Goodhart & Dimitrios P. Tsomocos & Alexandros P. Vardoulakis, 2015. "A Reconsideration of Minsky's Financial Instability Hypothesis," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 47(5), pages 931-973, August.
    22. Viral V. Acharya & Hyun Song Shin & Tanju Yorulmazer, 2011. "Crisis Resolution and Bank Liquidity," Review of Financial Studies, Society for Financial Studies, vol. 24(6), pages 2166-2205.
    23. Franklin Allen & Douglas Gale, 1998. "Optimal Financial Crises," Journal of Finance, American Finance Association, vol. 53(4), pages 1245-1284, August.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Choi, Dong Beom & Eisenbach, Thomas M. & Yorulmazer, Tanju, 2021. "Watering a lemon tree: Heterogeneous risk taking and monetary policy transmission," Journal of Financial Intermediation, Elsevier, vol. 47(C).
    2. , & Yorulmazer, Tanju, 2013. "Liquidity hoarding," Theoretical Economics, Econometric Society, vol. 8(2), May.
    3. Stijn Claessens & M Ayhan Kose, 2018. "Frontiers of macrofinancial linkages," BIS Papers, Bank for International Settlements, number 95.
    4. Abbassi, Puriya & Iyer, Rajkamal & Peydró, José-Luis & Tous, Francesc R., 2016. "Securities trading by banks and credit supply: Micro-evidence from the crisis," Journal of Financial Economics, Elsevier, vol. 121(3), pages 569-594.
    5. Ebrahimi Kahou, Mahdi & Lehar, Alfred, 2017. "Macroprudential policy: A review," Journal of Financial Stability, Elsevier, vol. 29(C), pages 92-105.
    6. Brunnermeier, Markus K. & Oehmke, Martin, 2013. "Bubbles, Financial Crises, and Systemic Risk," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, volume 2, chapter 0, pages 1221-1288, Elsevier.
    7. Roberto Robatto, 2019. "Systemic Banking Panics, Liquidity Risk, and Monetary Policy," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 34, pages 20-42, October.
    8. Kristian Blickle & Markus Brunnermeier & Stephan Luck, 2020. "Micro-evidence from a System-wide Financial Meltdown: The German Crisis of 1931," Working Papers 275, Princeton University, Department of Economics, Center for Economic Policy Studies..
    9. Abbassi, Puriya & Iyer, Rajkamal & Peydró, José-Luis & Tous, Francesc R., 2016. "Securities trading by banks and credit supply: Micro-evidence from the crisis," Journal of Financial Economics, Elsevier, vol. 121(3), pages 569-594.
    10. Elena Carletti & Agnese Leonello, 2019. "Credit Market Competition and Liquidity Crises," Review of Finance, European Finance Association, vol. 23(5), pages 855-892.
    11. Ahnert, Toni & Martinez-Miera, David, 2021. "Bank Runs, Bank Competition and Opacity," VfS Annual Conference 2021 (Virtual Conference): Climate Economics 242348, Verein für Socialpolitik / German Economic Association.
    12. Viral V. Acharya & Hyun Song Shin & Tanju Yorulmazer, 2011. "Crisis Resolution and Bank Liquidity," Review of Financial Studies, Society for Financial Studies, vol. 24(6), pages 2166-2205.
    13. Diane Pierret, 2015. "Systemic Risk and the Solvency-Liquidity Nexus of Banks," International Journal of Central Banking, International Journal of Central Banking, vol. 11(3), pages 193-227, June.
    14. Goldstein, Itay & Razin, Assaf, 2015. "Three Branches of Theories of Financial Crises," Foundations and Trends(R) in Finance, now publishers, vol. 10(2), pages 113-180, 30.
    15. Gazi I Kara & S Mehmet Ozsoy & Itay Goldstein, 2020. "Bank Regulation under Fire Sale Externalities [Is the international convergence of capital adequacy regulation desirable?]," Review of Financial Studies, Society for Financial Studies, vol. 33(6), pages 2554-2584.
    16. Martin, Antoine & Skeie, David & von Thadden, Ernst-Ludwig, 2014. "The fragility of short-term secured funding markets," Journal of Economic Theory, Elsevier, vol. 149(C), pages 15-42.
    17. Laurent Clerc & Alberto Giovannini & Sam Langfield & Tuomas Peltonen & Richard Portes & Martin Scheicher, 2016. "Indirect contagion: the policy problem," ESRB Occasional Paper Series 09, European Systemic Risk Board.
    18. Schilling, Linda, 2024. "Smooth Regulatory Intervention," MPRA Paper 120041, University Library of Munich, Germany.
    19. Zhiguo He & Wei Xiong, 2012. "Dynamic Debt Runs," Review of Financial Studies, Society for Financial Studies, vol. 25(6), pages 1799-1843.
    20. Kristian Blickle & Markus K. Brunnermeier & Stephan Luck, 2022. "Who Can Tell Which Banks Will Fail?," NBER Working Papers 29753, National Bureau of Economic Research, Inc.

    More about this item

    Keywords

    Bank runs; Fire sales; Bank liquidity; Banking crises; Local thinking;
    All these keywords.

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:ecofin:v:46:y:2018:i:c:p:89-102. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/inca/620163 .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.