Contagious Bank Runs and Dealer of Last Resort
60 Pages Posted: 24 May 2018 Last revised: 26 Dec 2019
Date Written: May 16, 2018
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: Suggested Citation