The Effect of Safe Assets on Financial Fragility in a Bank-Run Model

51 Pages Posted: 19 Dec 2014 Last revised: 10 Jan 2015

See all articles by Mahmoud Elamin

Mahmoud Elamin

Federal Reserve Banks - Federal Reserve Bank of Cleveland

Toni Ahnert

European Central Bank, Financial Research Division; Centre for Economic Policy Research (CEPR)

Date Written: December 17, 2014

Abstract

Risk-averse investors induce competitive intermediaries to hold safe assets, thereby lowering the probability of a run and reducing financial fragility. We revisit Goldstein and Pauzner (2005), who obtain a unique equilibrium in the banking model of Diamond and Dybvig (1983) by introducing risky investment and noisy private signals. We show that, in the optimal demand-deposit contract subject to sequential service, banks hold safe assets to insure investors against investment risk. Consequently, fewer investors withdraw prematurely, which reduces the probability of a bank run. Safe asset holdings increase investor welfare and may increase the bank’s provision of liquidity.

Keywords: bank runs, demand deposits, global games, liquidity provision, safe assets,

JEL Classification: D8, G21

Suggested Citation

Elamin, Mahmoud and Ahnert, Toni, The Effect of Safe Assets on Financial Fragility in a Bank-Run Model (December 17, 2014). FRB of Cleveland Working Paper No. 14-37, Available at SSRN: https://ssrn.com/abstract=2539801 or http://dx.doi.org/10.2139/ssrn.2539801

Mahmoud Elamin (Contact Author)

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

East 6th & Superior
Cleveland, OH 44101-1387
United States

Toni Ahnert

European Central Bank, Financial Research Division ( email )

ECB Tower
Sonnemannstraße 20
Frankfurt am Main

HOME PAGE: http://toniahnert.com

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
58
Abstract Views
712
Rank
537,667
PlumX Metrics