Liquidity Requirements, Liquidity Choice and Financial Stability

45 Pages Posted: 7 Mar 2016

See all articles by Douglas W. Diamond

Douglas W. Diamond

University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER)

Anil K. Kashyap

University of Chicago, Booth School of Business; National Bureau of Economic Research (NBER); Federal Reserve Bank of Chicago

Date Written: March 2016

Abstract

We study a modification of the Diamond and Dybvig (1983) model in which the bank may hold a liquid asset, some depositors see sunspots that could lead them to run, and all depositors have incomplete information about the bank’s ability to survive a run. The incomplete information means that the bank is not automatically incentivized to always hold enough liquid assets to survive runs. Regulation similar to the liquidity coverage ratio and the net stable funding ratio (that are soon be implemented) can change the bank’s incentives so that runs are less likely. Optimal regulation would not mimic these rules.

Suggested Citation

Diamond, Douglas W. and Kashyap, Anil K., Liquidity Requirements, Liquidity Choice and Financial Stability (March 2016). NBER Working Paper No. w22053, Available at SSRN: https://ssrn.com/abstract=2743052

Douglas W. Diamond (Contact Author)

University of Chicago - Booth School of Business ( email )

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National Bureau of Economic Research (NBER)

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Anil K. Kashyap

University of Chicago, Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
773-702-7260 (Phone)
773 702-0458 (Fax)

National Bureau of Economic Research (NBER) ( email )

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United States
773-702-7260 (Phone)
773-702-0458 (Fax)

Federal Reserve Bank of Chicago ( email )

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United States

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