Correlated observations, the law of small numbers and bank runs

Gergely Horvath and Hubert Janos Kiss

No 1429, CERS-IE WORKING PAPERS from Institute of Economics, Centre for Economic and Regional Studies

Abstract: Empirical descriptions and studies suggest that generally depositors observe a sample of previous decisions before deciding if to keep their funds deposited or to withdraw them. These observed decisions may exhibit different degrees of correlation across depositors. In our model depositors are assumed to follow the law of small numbers in the sense that they believe that a bank run is underway if the number of observed withdrawals in their sample is high. Theoretically, with highly correlated samples and infinite depositors runs occur with certainty, while with random samples it needs not be the case, as for many parameter settings the likelihood of bank runs is less than one. To investigate the intermediate cases, we use simulations and find that decreasing the correlation reduces the likelihood of bank runs, often in a non-linear way. We also study the effect of the sample size and show that increasing it makes bank runs less likely. Our results have relevant policy implications.

Keywords: bank runs; law of small numbers; samples; threshold decision rule (search for similar items in EconPapers)
JEL-codes: D03 G01 G02 (search for similar items in EconPapers)
Pages: 31 pages
Date: 2014-11
New Economics Papers: this item is included in nep-ban
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Journal Article: Correlated Observations, the Law of Small Numbers and Bank Runs (2016)
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