Information Disclosure and Financial Fragility
52 Pages Posted: 13 Jul 2021
Date Written: July 11, 2021
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: Suggested Citation