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Bank Runs and Investment Decisions Revisited

  • Todd Keister
  • Huberto M. Ennis

In this paper we extend the Cooper and Ross (1998) analysis of the optimal response of a competitive bank to the possibility of a bank run. If the probability of a run is small, the bank will offer a contract that admits a bank-run equilibrium. We show that, in this case, the bank will hold a quantity of liquid assets large enough to exactly meet withdrawal demand if a run does not occur; "excess" liquidity will not be held. This result allows us to determine how the possibility of a bank run affects the level of long-term investment chosen by a bank. We show that when the cost of liquidating investment early is high, the level of investment is decreasing in the probability of a run. However, when liquidation costs are smaller, the level of investment is actually increasing in the probability of a run.

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Paper provided by Society for Economic Dynamics in its series 2004 Meeting Papers with number 180.

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Date of creation: 2004
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Handle: RePEc:red:sed004:180
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  1. John H. Boyd & Pedro Gomis & Sungkyu Kwak & Bruce D. Smith, 2000. "A User's Guide to Banking Crises," Monash Economics Working Papers archive-36, Monash University, Department of Economics.
  2. Ennis, Huberto M. & Keister, Todd, 2003. "Economic growth, liquidity, and bank runs," Journal of Economic Theory, Elsevier, vol. 109(2), pages 220-245, April.
  3. Freeman, Scott, 1988. "Banking as the Provision of Liquidity," The Journal of Business, University of Chicago Press, vol. 61(1), pages 45-64, January.
  4. 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.
  5. Peck, James & Shell, Karl, 2001. "Equilibrium Bank Runs," Working Papers 01-10r, Cornell University, Center for Analytic Economics.
  6. Champ, B. & Smith, B.D., 1991. "Currency Elasticity and Banking Panics: theory and Evidence," University of Western Ontario, The Centre for the Study of International Economic Relations Working Papers 9109, University of Western Ontario, The Centre for the Study of International Economic Relations.
  7. Edward J. Green & Ping Lin, 1996. "Implementing efficient allocations in a model of financial intermediation," Working Papers 576, Federal Reserve Bank of Minneapolis.
  8. Huberto M. Ennis & Todd Keister, 2003. "Government Policy and the Probability of Coordination Failures," Working Papers 0301, Centro de Investigacion Economica, ITAM.
  9. Alejandro Gaytan & Romain Rancière, 2001. "Banks, liquidity crises and economic growth," Economics Working Papers 853, Department of Economics and Business, Universitat Pompeu Fabra, revised May 2003.
  10. Russell Cooper & Thomas W. Ross, 1991. "Bank Runs: Liquidity and Incentives," NBER Working Papers 3921, National Bureau of Economic Research, Inc.
  11. Neil Wallace, 1990. "A banking model in which partial suspension is best," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 11-23.
  12. Caprio, Gerard Jr. & Klingebiel, Daniela, 1996. "Bank insolvencies : cross-country experience," Policy Research Working Paper Series 1620, The World Bank.
  13. 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.
  14. 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.
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