Asymmetric Information and Bank Runs

It is known that sunspots can trigger panic-based bank runs and that the optimal banking contract can tolerate panic-based runs. The existing literature assumes that these sunspots are based on a publicly observed extrinsic randomizing device. In this paper, I extend the analysis of panic-based runs to include an asymmetric-information, extrinsic randomizing device. Depositors observe different, but correlated, signals on the stability of the bank. I find that if the signals that depositors obtain are highly correlated, there exists a correlated equilibrium for some demand deposit contracts. In this equilibrium, either a full bank run, or a partial bank run, or non bank run occurs depending on the realization of the signals. Computed examples indicate that in some economies, a demand-deposit contract that tolerates bank runs and partial bank runs is optimal; while in some other economies a run-proof contract is optimal.

Do social networks prevent bank runs?

We develop, both theoretically and experimentally, a stereotypical environment that allows for coordination breakdown, leading to a bank run. Three depositors are located at the nodes of a network and have to decide whether to keep their funds deposited or to withdraw. One of the depositors has immediate liquidity needs, whereas the other two depositors do not. Depositors act sequentially and observe others actions only if connected by the network. Theoretically, a link connecting the first two depositors to decide is sufficient to avoid a bank run. However, our experimental evidence shows that subjects¿ choice is not affected by the existence of the link per se. Instead, being observed and the particular action that is observed determine subjects¿ choice. Our results highlight the importance of initial decisions in the emergence of a bank run. In particular, Bayesian analysis reveals that subjects clearly depart from predicted behavior when observing a withdrawal.bank runs, coordination failures, experimental evidence, networks

Why do bank runs look like panic? A new explanation

This paper demonstrates that, even if depositors are fully rational and always choose the Pareto dominant equilibrium when there are multiple equilibria, a bank run may still occur when depositors’ expectations of the bank’s fundamentals do not change. More specifically, a bank run may occur when depositors learn that noisy bank-specific information is revealed, or when they learn that precise bank-specific information is not revealed. The results in this paper are consistent with empirical evidence about bank runs. It also implies that suspension of convertibility can improve the efficiency of bank runs.bank run; banking panic; suspension of convertibility

The Diamond-Rajan Bank Runs in a Production Economy

To analyze the macroeconomic consequences of a systemic bank run, we integrate the banking model `a la Diamond and Rajan (2001a) into a simplified version of an infinite-horizon neoclassical growth model. The banking sector intermediates the collateral-secured loans from households to entrepreneurs. The entrepreneurs also deposit their working capital in the banks. The systemic bank run, which is a sunspot phenomenon in this model, results in a deep recession through causing a sudden shortage of the working capital. We show that an increase in the probability of occurrence of the systemic run can persistently lower output, consumption, labor, capital and the asset price, even if the systemic run does not actually occur. This result implies that the slowdown of economic growth after the financial crises may be caused by the increased fragility of the banking system or the raised fears of recurrence of the systemic runs.

Liquidity Black Holes

Traders with short horizons and privately known trading limits interact in a market for a risky asset. Risk-averse, long horizon traders supply a downward sloping residual demand curve that face the short-horizon traders. When the price falls close to the trading limits of the short horizon traders, selling of the risky asset by any trader increases the incentives for others to sell. Sales become mutually reinforcing among the short term traders, and payoffs analogous to a bank run are generated. A "liquidity black hole" is the analogue of the run outcome in a bank run model. Short horizon traders sell because others sell. Using global game techniques, this paper solves for the unique trigger point at which the liquidity black hole comes into existence. Empirical implications include the sharp V-shaped pattern in prices around the time of the liquidity black hole.Liquidity, Asset pricing, Global games

Moral Hazard in a model of Bank Run with Noisy Signals

We show that multiple equilibria exist in a model of bank run with moral hazard. Furthermore, this is true even with noisy signals on the economic fundamentals. We argue that the conditions under which this happens can arise naturally in models of banking with moral hazard problem.banking, fundamentals, signals, equilibria

Would depositors pay to show that they do not withdraw? Theory and experiment

In a Diamond–Dybvig type model of fnancial intermediation, we allow depositors to announce at a positive cost to subsequent depositors that they keep their funds deposited in the bank. Theoretically, the mere availability of public announcements (and not its use) ensures that no bank run is the unique equilibrium outcome. Multiple equilibria—including bank run—exist without such public announcements. We test the theoretical results in the lab and fnd a widespread use of announcements, which we interpret as an attempt to coordinate on the no bank run outcome. Withdrawal rates in general are lower in information sets that contain announcement

Panic of 1907

Bank panics were a regular occurrence in the late 19th and early 20th centuries. The failure of one commodity speculator in October 1907 triggered a nationwide bank run. This publication tells how the panic developed, spread, and was resolved. A chronology is included along with a section of newspaper excerpts.Bank failures ; Financial crises

Optimal deposit contracts: do-it-yourself bank-run prevention for banks

The need for federal deposit insurance is often based on the claim that it prevents bank runs and makes the banking system more stable. But research shows that banks could prevent bank runs by constructing their deposit contracts appropriately, and, in the absence of deposit insurance, they would do so in their own self interest. Federal deposit insurance may be useful as insurance per se—protecting depositors against unforeseen accidents—but it should not be considered necessary for banking system stability.Deposit insurance ; Financial crises ; Bank failures