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Equilibrium Bank Runs

  • James Peck
  • Karl Shell

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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Article provided by University of Chicago Press in its journal Journal of Political Economy.

Volume (Year): 111 (2003)
Issue (Month): 1 (February)
Pages: 103-123

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Handle: RePEc:ucp:jpolec:v:111:y:2003:i:1:p:103-123
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