Bank Runs and Investment Decisions Revisited

24 Pages Posted: 5 Dec 2012 Last revised: 20 Feb 2013

See all articles by Huberto M. Ennis

Huberto M. Ennis

Federal Reserve Banks - Federal Reserve Bank of Richmond

Todd Keister

Rutgers, The State University of New Jersey - Department of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: March 1, 2004

Abstract

We examine how the possibility of a bank run affects the deposit contract offered and the investment decisions made by a competitive bank. Cooper and Ross (1998) have shown that when 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 chose to hold an amount of liquid reserves exactly equal to what withdrawal demand will be if a run does not occur. In other words, precautionary or "excess" liquidity will not be held. This result allows us to determine how the possibility of a bank run affects the level of illiquid 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 moderate, the level of investment is actually increasing in the probability of a run.

Keywords: bank runs, deposit contracts, bank reserves, sunspot equilibrium

JEL Classification: D84, E44, G21

Suggested Citation

Ennis, Huberto M. and Keister, Todd, Bank Runs and Investment Decisions Revisited (March 1, 2004). FRB Richmond Working Paper No. 04-03. Available at SSRN: https://ssrn.com/abstract=2184950 or http://dx.doi.org/10.2139/ssrn.2184950

Huberto M. Ennis (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Richmond ( email )

P.O. Box 27622
Richmond, VA 23261
United States

Todd Keister

Rutgers, The State University of New Jersey - Department of Economics ( email )

75 Hamilton Street
New Brunswick, NJ 08901
United States

HOME PAGE: http://econweb.rutgers.edu/tkeister

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