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On the Existence of Equilibrium Bank Runs in a Diamond-Dybvig Environment

  • Carmona, Guilherme

In a version of the Diamond and Dybvig [6] model with aggregate uncertainty, we show that there exists an equilibrium with the following properties: all consumers deposit at the bank, all patient consumers wait for the last period to withdraw, and the bank fails with strictly positive probability. Furthermore, we show that the probability of a bank failure remains bounded away from zero as the number of consumers increases. We interpret such an equilibrium as reflecting a bank run, defined as an episode in which a large number of people withdraw their deposits from a bank, forcing it to fail. Our results show that we can have equilibrium bank runs with consumers poorly informed about the true state of nature, a sequential service constraint, an infinite marginal utility of consumption at zero, and without consumers panic and sunspots. We therefore think that aggregate risk in Diamond-Dybvig-like environments can be an important element to explain bank runs.

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Paper provided by Universidade Nova de Lisboa, Faculdade de Economia in its series FEUNL Working Paper Series with number wp448.

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Length: 32 pages
Date of creation: 2004
Date of revision:
Handle: RePEc:unl:unlfep:wp448
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  1. Bernardino Adao & Ted Temzelides, 1998. "Sequential Equilibrium and Competition in a Diamond-Dybvig Banking Model," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 1(4), pages 859-877, October.
  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. Barlo, Mehmet & Carmona, Guilherme, 2011. "Strategic behavior in non-atomic games," MPRA Paper 35549, University Library of Munich, Germany.
  4. James Peck & Karl Shell, 2003. "Equilibrium Bank Runs," Journal of Political Economy, University of Chicago Press, vol. 111(1), pages 103-123, February.
  5. Karl Shell & James Peck, 2004. "Bank Portfolio Restrictions and Equilibrium Bank Runs," 2004 Meeting Papers 359, Society for Economic Dynamics.
  6. Neil Wallace, 1990. "A banking model in which partial suspension is best," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 11-23.
  7. 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.
  8. Huberto M. Ennis & Todd Keister, 2003. "Economic growth, liquidity, and bank runs," Working Paper 03-01, Federal Reserve Bank of Richmond.
  9. Hildenbrand, Werner, 1971. "Random preferences and equilibrium analysis," Journal of Economic Theory, Elsevier, vol. 3(4), pages 414-429, December.
  10. Edward J. Green, 1995. "Implementing Efficient Allocations in a Model of Financial Intermediation," Meeting papers 9506001, EconWPA.
  11. Carmona, Guilherme, 2004. "Nash and Limit Equilibria of Games with a Continuum of Players," FEUNL Working Paper Series wp442, Universidade Nova de Lisboa, Faculdade de Economia.
  12. Graciela L. Kaminsky & Carmen M. Reinhart, 1996. "The twin crises: the causes of banking and balance-of-payments problems," International Finance Discussion Papers 544, Board of Governors of the Federal Reserve System (U.S.).
  13. Franklin Allen & Douglas Gale, 1998. "Optimal Financial Crises," Journal of Finance, American Finance Association, vol. 53(4), pages 1245-1284, 08.
  14. Gary Gorton, 1986. "Banking panics and business cycles," Working Papers 86-9, Federal Reserve Bank of Philadelphia.
  15. Bernadino Adao & Theodosios Temzelides, 1995. "Beliefs, competition, and bank runs," Working Papers 95-26, Federal Reserve Bank of Philadelphia.
  16. 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.
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