Interest rates and financial fragility

Yang Li ()

Journal of Economic Dynamics and Control, 2017, vol. 82, issue C, 195-205

Abstract: How do the interest rates banks earn on their assets affect the susceptibility of the banking system to a self-fulfilling run by depositors? I study this question in a version of the model of Diamond and Dybvig (1983) with limited commitment and a non-trivial portfolio choice. I show that the relationship between these interest rates and financial fragility is often non-monotone. For example, a small increase in the return on illiquid investment (or a small increase in the term premium) may raise banks’ susceptibility to a run, while a larger increase would make the banking system more stable. The same is true for changes in short-term rates, holding the longer-term rates fixed. I provide a precise characterization of these comparative statics of financial fragility.

Keywords: Bank runs; Excess liquidity; Financial fragility; Portfolio choice; Term premium (search for similar items in EconPapers)
JEL-codes: E43 E44 G21 (search for similar items in EconPapers)
Date: 2017
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (12)

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S0165188917301458
Full text for ScienceDirect subscribers only

Related works:
Working Paper: Asset Returns and Financial Fragility (2016)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:82:y:2017:i:c:p:195-205

DOI: 10.1016/j.jedc.2017.06.009

Access Statistics for this article

Journal of Economic Dynamics and Control is currently edited by J. Bullard, C. Chiarella, H. Dawid, C. H. Hommes, P. Klein and C. Otrok

More articles in Journal of Economic Dynamics and Control from Elsevier
Bibliographic data for series maintained by Catherine Liu ().