Time vs. Risk Preferences, Bank Liquidity Provision and Financial Fragility

Ettore Panetti

Working Papers from Banco de Portugal, Economics and Research Department

Abstract: How important is it to distinguish relative risk aversion (RRA) from the intertemporal elasticity of substitution (IES) to understand bank liquidity provision and financial fragility? To answer this question, I develop a banking theory in which depositors feature Epstein-Zin preferences. In equilibrium, banks provide liquidity when RRA is sufficiently high (low) only for IES larger (smaller) than 1. Under the same conditions, banks might be fragile, i.e. subject to possible self-fulfilling depositors' runs. A time-consistent deposit freeze resolves banks' fragility if RRA is sufficiently low and IES is sufficiently larger than 1.

JEL-codes: D81 G21 G28 (search for similar items in EconPapers)
Date: 2019
New Economics Papers: this item is included in nep-ban, nep-cba and nep-upt
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Persistent link: https://EconPapers.repec.org/RePEc:ptu:wpaper:w201917

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