Equilibrium Bank Runs
We analyze a banking system in which the class of feasible deposit contracts, or mechanisms, is broad. The mechanisms must satisfy a sequential service constraint, but partial or full suspension of convertibility is allowed. Consumers must be willing to deposit, ex ante. We show, by examples, that under the so-called "optimal contract," the postdeposit game can have a run equilibrium. Given a propensity to run, triggered by sunspots, the optimal contract for the full predeposit game can be consistent with runs that occur with positive probability. Thus the Diamond-Dybvig framework can explain bank runs as emerging in equilibrium under the optimal deposit contract.
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- Douglas W. Diamond & Raghuram G. Rajan, .
"Liquidity Risk, Liquidity Creation and Financial Fragility: A Theory of Banking,"
CRSP working papers
476, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
- Douglas W. Diamond & Raghuram G. Rajan, 1998. "Liquidity risk, liquidity creation and financial fragility: a theory of banking," Proceedings, Federal Reserve Bank of San Francisco, issue Sep.
- Douglas W. Diamond & Raghuram G. Rajan, 2001. "Liquidity Risk, Liquidity Creation, and Financial Fragility: A Theory of Banking," Journal of Political Economy, University of Chicago Press, vol. 109(2), pages 287-327, April.
- Douglas W. Diamond & Raghuram G. Rajan, 1999. "Liquidity Risk, Liquidity Creation and Financial Fragility: A Theory of Banking," NBER Working Papers 7430, National Bureau of Economic Research, Inc.
- Douglas W. Diamond & Philip H. Dybvig, 2000.
"Bank runs, deposit insurance, and liquidity,"
Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
- Calomiris, Charles W & Kahn, Charles M, 1991. "The Role of Demandable Debt in Structuring Optimal Banking Arrangements," American Economic Review, American Economic Association, vol. 81(3), pages 497-513, June.
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