The Effect of Safe Assets on Financial Fragility in a Bank-Run Model

Toni Ahnert and Mahmoud Elamin

No 1437, Working Papers (Old Series) from Federal Reserve Bank of Cleveland

Abstract: Risk-averse investors induce competitive intermediaries to hold safe assets, thereby lowering the probability of a run and reducing financial fragility. We revisit Goldstein and Pauzner (2005), who obtain a unique equilibrium in the banking model of Diamond and Dybvig (1983) by introducing risky investment and noisy private signals. We show that, in the optimal demand-deposit contract subject to sequential service, banks hold safe assets to insure investors against investment risk. Consequently, fewer investors withdraw prematurely, which reduces the probability of a bank run. Safe asset holdings increase investor welfare and may increase the bank?s provision of liquidity.

Keywords: bank runs; demand deposits; global games; liquidity provision; safe assets (search for similar items in EconPapers)
JEL-codes: D8 G21 (search for similar items in EconPapers)
Pages: 51 pages
Date: 2014-12-22
References: Add references at CitEc
Citations: View citations in EconPapers (5)

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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedcwp:1437

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DOI: 10.26509/frbc-wp-201437

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