IDEAS home Printed from https://ideas.repec.org/p/fip/fedhwp/wp-2014-19.html
   My bibliography  Save this paper

Preventing Bank Runs

Author

Listed:
  • Andolfatto, David

    () (Federal Reserve Bank of St. Louis)

  • Nosal, Ed

    (Federal Reserve Bank of Chicago)

  • Sultanum, Bruno

    (Pennsylvania State University)

Abstract

Diamond and Dybvig (1983) is commonly understood as providing a formal rationale for the existence of bank-run equilibria. It has never been clear, however, whether bank-run equilibria in this framework are a natural byproduct of the economic environment or an artifact of suboptimal contractual arrangements. In the class of direct mechanisms, Peck and Shell (2003) demonstrate that bank-run equilibria can exist under an optimal contractual arrangement. The difficulty of preventing runs within this class of mechanism is that banks cannot identify whether withdrawals are being driven by psychology or by fundamentals. Our solution to this problem is an indirect mechanism with the following two properties. First, it provides depositors an incentive to communicate whether they believe a run is on or not. Second, the mechanism threatens a suspension of convertibility conditional on what is revealed in these communications. Together, these two properties can eliminate the prospect of bank-run equilibria in the Diamond-Dybvig environment.

Suggested Citation

  • Andolfatto, David & Nosal, Ed & Sultanum, Bruno, 2014. "Preventing Bank Runs," Working Paper Series WP-2014-19, Federal Reserve Bank of Chicago.
  • Handle: RePEc:fip:fedhwp:wp-2014-19
    as

    Download full text from publisher

    File URL: https://www.chicagofed.org/digital_assets/publications/working_papers/2014/wp2014_19.pdf
    File Function: Full text
    Download Restriction: no

    Other versions of this item:

    References listed on IDEAS

    as
    1. Andolfatto, David & Nosal, Ed & Wallace, Neil, 2007. "The role of independence in the Green-Lin Diamond-Dybvig model," Journal of Economic Theory, Elsevier, vol. 137(1), pages 709-715, November.
    2. Green, Edward J. & Lin, Ping, 2003. "Implementing efficient allocations in a model of financial intermediation," Journal of Economic Theory, Elsevier, vol. 109(1), pages 1-23, March.
    3. Salih N. Neftci & Andre O Santos, 2003. "Puttable and Extendible Bonds; Developing Interest Rate Derivatives for Emerging Markets," IMF Working Papers 03/201, International Monetary Fund.
    4. R. de O. Cavalcanti & P. K. Monteiro, 2016. "Enriching information to prevent bank runs," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 62(3), pages 477-494, August.
    5. Russell Cooper & Thomas W. Ross, 2002. "Bank Runs: Deposit Insurance and Capital Requirements," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 43(1), pages 55-72, February.
    6. Huberto M. Ennis & Todd Keister, 2009. "Bank Runs and Institutions: The Perils of Intervention," American Economic Review, American Economic Association, vol. 99(4), pages 1588-1607, September.
    7. Ennis, Huberto M. & Keister, Todd, 2009. "Run equilibria in the Green-Lin model of financial intermediation," Journal of Economic Theory, Elsevier, vol. 144(5), pages 1996-2020, September.
    8. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
    9. Dilip Mookherjee & Stefan Reichelstein, 1990. "Implementation via Augmented Revelation Mechanisms," Review of Economic Studies, Oxford University Press, vol. 57(3), pages 453-475.
    10. Gorton, Gary, 1985. "Clearinghouses and the Origin of Central Banking in the United States," The Journal of Economic History, Cambridge University Press, vol. 45(02), pages 277-283, June.
    11. Ma, Ching-to & Moore, John & Turnbull, Stephen, 1988. "Stopping agents from "cheating"," Journal of Economic Theory, Elsevier, vol. 46(2), pages 355-372, December.
    12. Demski, Joel S. & Sappington, David, 1984. "Optimal incentive contracts with multiple agents," Journal of Economic Theory, Elsevier, vol. 33(1), pages 152-171, June.
    13. James Peck & Karl Shell, 2003. "Bank Portfolio Restrictions and Equilibrium Bank Runs," Levine's Bibliography 666156000000000077, UCLA Department of Economics.
    14. James Peck & Karl Shell, 2003. "Equilibrium Bank Runs," Journal of Political Economy, University of Chicago Press, vol. 111(1), pages 103-123, February.
    15. Postlewaite, Andrew & Schmeidler, David, 1986. "Implementation in differential information economies," Journal of Economic Theory, Elsevier, vol. 39(1), pages 14-33, June.
    16. Bryant, John, 1980. "A model of reserves, bank runs, and deposit insurance," Journal of Banking & Finance, Elsevier, vol. 4(4), pages 335-344, December.
    17. Neil Wallace, 1990. "A banking model in which partial suspension is best," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 11-23.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Andolfatto, David & Nosal, Ed, 2017. "Bank Panics and Scale Economies," Working Papers 2017-9, Federal Reserve Bank of St. Louis.
    2. Huberto Ennis & Todd Keister, 2016. "Optimal banking contracts and financial fragility," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 61(2), pages 335-363, February.
    3. Li, Yang, 2017. "Interest rates and financial fragility," Journal of Economic Dynamics and Control, Elsevier, vol. 82(C), pages 195-205.
    4. Bruno Sultanum, 2014. "Financial fragility and over-the-counter markets," 2014 Papers psu420, Job Market Papers.
    5. Zhen Zhou & Deepal Basak, 2015. "Diffusing Coordination Risk," 2015 Meeting Papers 1350, Society for Economic Dynamics.
    6. Markus Kinateder & Hubert Janos Kiss & Agnes Pinter, 2015. "Would depositors like to show others that they do not withdraw? Theory and Experiment," IEHAS Discussion Papers 1553, Institute of Economics, Centre for Economic and Regional Studies, Hungarian Academy of Sciences.
    7. Fernando Martin & Aleksander Berentsen & David Andolfatto, 2016. "Financial Fragility in Monetary Economies," 2016 Meeting Papers 1626, Society for Economic Dynamics.
    8. Simas Kucinskas, 2015. "Liquidity Creation without Banks," Tinbergen Institute Discussion Papers 15-101/VI, Tinbergen Institute.
    9. Simas Kucinskas, 2015. "Liquidity creation without banks," DNB Working Papers 482, Netherlands Central Bank, Research Department.
    10. Roberto Robatto, 2015. "Financial Crises and Systemic Bank Runs in a Dynamic Model of Banking," 2015 Meeting Papers 483, Society for Economic Dynamics.

    More about this item

    Keywords

    Bank runs; optimal deposit contract; financial fragility;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

    NEP fields

    This paper has been announced in the following NEP Reports:

    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:fip:fedhwp:wp-2014-19. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Bernie Flores). General contact details of provider: http://edirc.repec.org/data/frbchus.html .

    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 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.

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

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.