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Run equilibria in a model of financial intermediation

  • Huberto M. Ennis
  • Todd Keister

We study the Green and Lin (2003) model of financial intermediation with two new features: traders may face a cost of contacting the intermediary, and consumption needs may be correlated across traders. We show that each feature is capable of generating an equilibrium in which some (but not all) traders “run” on the intermediary by withdrawing their funds at the first opportunity regardless of their true consumption needs. Our results also provide some insight into elements of the economic environment that are necessary for a run equilibrium to exist in general models of financial intermediation. In particular, our findings highlight the importance of information frictions that cause the intermediary and traders to have different beliefs, in equilibrium, about the consumption needs of traders who have yet to contact the intermediary.

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Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 312.

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Date of creation: 2008
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Handle: RePEc:fip:fednsr:312
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  1. Andolfatto, David, 2007. "Bank Incentives, Contract Design, and Bank Runs," MPRA Paper 8146, University Library of Munich, Germany.
  2. Neil Wallace, 1988. "Another attempt to explain an illiquid banking system: the Diamond and Dybvig model with sequential service taken seriously," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 3-16.
  3. David Andolfatto & Ed Nosal & Neil Wallace, 2006. "The role of independence in the Green-Lin Diamond-Dybvig model," Working Paper 0615, Federal Reserve Bank of Cleveland.
  4. Todd Keister & Huberto M. Ennis, 2007. "Commitment and Equilibrium Bank Runs," 2007 Meeting Papers 509, Society for Economic Dynamics.
  5. Edward J. Green & Ping Lin, 1996. "Implementing efficient allocations in a model of financial intermediation," Working Papers 576, Federal Reserve Bank of Minneapolis.
  6. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June.
  7. Neil Wallace, 1990. "A banking model in which partial suspension is best," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 11-23.
  8. James Peck & Karl Shell, 2003. "Equilibrium Bank Runs," Journal of Political Economy, University of Chicago Press, vol. 111(1), pages 103-123, February.
  9. Edward J. Green & Ping Lin, 2000. "Diamond and Dybvig's classic theory of financial intermediation : what's missing?," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 3-13.
  10. Cooper, Russell & Ross, Thomas W., 1998. "Bank runs: Liquidity costs and investment distortions," Journal of Monetary Economics, Elsevier, vol. 41(1), pages 27-38, February.
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