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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. Guilherme Carmona, 2003. "Nash and Limit Equilibria of Games with a Continuum of Players," Game Theory and Information 0311004, EconWPA.
  2. 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.).
  3. Gary Gorton, 1986. "Banking panics and business cycles," Working Papers 86-9, Federal Reserve Bank of Philadelphia.
  4. Barlo, Mehmet & Carmona, Guilherme, 2011. "Strategic behavior in non-atomic games," MPRA Paper 35549, University Library of Munich, Germany.
  5. James Peck & Karl Shell, 2003. "Equilibrium Bank Runs," Journal of Political Economy, University of Chicago Press, vol. 111(1), pages 103-123, February.
  6. Hildenbrand, Werner, 1971. "Random preferences and equilibrium analysis," Journal of Economic Theory, Elsevier, vol. 3(4), pages 414-429, December.
  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. Franklin Allen & Douglas Gale, 1998. "Optimal Financial Crises," Journal of Finance, American Finance Association, vol. 53(4), pages 1245-1284, 08.
  9. Karl Shell & James Peck, 2004. "Bank Portfolio Restrictions and Equilibrium Bank Runs," 2004 Meeting Papers 359, Society for Economic Dynamics.
  10. 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.
  11. 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.
  12. 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.
  13. 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.
  14. Ennis, Huberto M. & Keister, Todd, 2003. "Economic growth, liquidity, and bank runs," Journal of Economic Theory, Elsevier, vol. 109(2), pages 220-245, April.
  15. 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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