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Asymmetric Information and Bank Runs

  • Gu, Chao

    (U of Missouri, Columbia)

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It is known that sunspots can trigger panic-based bank runs and that the optimal banking contract can tolerate panic-based runs. The existing literature assumes that these sunspots are based on a publicly observed extrinsic randomizing device. In this paper, I extend the analysis of panic-based runs to include an asymmetric-information, extrinsic randomizing device. Depositors observe different, but correlated, signals on the stability of the bank. I find that if the signals that depositors obtain are highly correlated, there exists a correlated equilibrium for some demand deposit contracts. In this equilibrium, either a full bank run, or a partial bank run, or non bank run occurs depending on the realization of the signals. Computed examples indicate that in some economies, a demand-deposit contract that tolerates bank runs and partial bank runs is optimal; while in some other economies a run-proof contract is optimal.

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File URL: https://cae.economics.cornell.edu/07-14.pdf
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Paper provided by Cornell University, Center for Analytic Economics in its series Working Papers with number 07-14.

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Date of creation: Oct 2007
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Handle: RePEc:ecl:corcae:07-14
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