Information Disclosure and Financial Fragility

52 Pages Posted: 13 Jul 2021

See all articles by Xuesong Huang

Xuesong Huang

Lingnan College (University), Sun Yat-sen University; Rutgers, The State University of New Jersey - Rutgers University

Date Written: July 11, 2021

Abstract

I study how banks and other financial intermediaries can use information disclosure to prevent self-fulfilling bank runs. I begin with a finite-agent version of Diamond and Dybvig (1983) with correlated liquidity shocks and sequential service. I allow the intermediary to inform each investor about the withdrawal decisions of previous investors. Adding information disclosure creates a withdrawal game with sequential signaling, and I argue using examples that it is natural to introduce an equilibrium concept placing restrictions on agents’ off equilibrium beliefs. I use the concept of forward induction equilibrium (Cho, 1987) that generalizes the “intuitive” criterion. I provide conditions under which the induced withdrawal game has a unique forward induction equilibrium and no bank run occurs. In other words, disclosing withdrawal information can promote financial stability.

Keywords: Information disclosure; Signaling; Forward induction equilibrium; Financial stability; Correlated types.

JEL Classification: D82, D83, G21

Suggested Citation

Huang, Xuesong, Information Disclosure and Financial Fragility (July 11, 2021). Available at SSRN: https://ssrn.com/abstract=3884384 or http://dx.doi.org/10.2139/ssrn.3884384

Xuesong Huang (Contact Author)

Lingnan College (University), Sun Yat-sen University ( email )

GuangZhou, GuangDong
China

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

311 Armitage Hall
N. 5th Street, room 313
Camden, NJ 08102
United States

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