Contagious Bank Runs and Dealer of Last Resort

60 Pages Posted: 24 May 2018 Last revised: 5 Jun 2018

See all articles by Zhao Li

Zhao Li

University of International Business and Economics (UIBE) - School of Banking and Finance

Kebin Ma

University of Warwick - Finance Group

Date Written: May 16, 2018

Abstract

In a global-games framework, we show how a dealer-of-last-resort policy can promote financial stability while traditional lender-of-last-resort policies are informationally constrained: Central banks and private investors can be uncertain whether banks selling assets to fend off runs are insolvent or illiquid. Such uncertainty leads to asset price collapses and runs and restricts central banks' role as a lender of last resort. In the presence of aggregate uncertainty, contagion and price volatility emerge as a multiple-equilibria phenomenon despite the global-games refinement. A dealer-of-last-resort policy that requires no information on individual banks' solvency can contain contagion and stabilize prices at zero-expected costs.

Keywords: Banking Regulation and Systemic Risk, Banking/Financial Intermediation, Financial Crisis

JEL Classification: G01, G11, G21

Suggested Citation

Li, Zhao and Ma, Kebin, Contagious Bank Runs and Dealer of Last Resort (May 16, 2018). Paris December 2018 Finance Meeting EUROFIDAI - AFFI. Available at SSRN: https://ssrn.com/abstract=3179438 or http://dx.doi.org/10.2139/ssrn.3179438

Zhao Li

University of International Business and Economics (UIBE) - School of Banking and Finance ( email )

No.10, Huixindong Street
Chaoyang District
Beijing, 100029
China

Kebin Ma (Contact Author)

University of Warwick - Finance Group ( email )

Gibbet Hill Rd
Coventry, CV4 7AL
Great Britain

HOME PAGE: http://www.kebinma.com

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