 Liquidity, bank runs, and fire sales under local thinkingHyun Woong Park and Thomas Bernardin The North American Journal of Economics and Finance, 2018, vol. 46, issue C, 89-102 Abstract: We examine the implications on banking crises when markets are populated by agents that neglect tail risks and form expectations conditioned on a favorable subset of possible states of the economy. We find that optimal bank liquidity is lower than would be the case under rational expectations, and, consequently, the banking system is more vulnerable to adverse shocks, which lead to bank runs. Asset pledgeability of surviving banks is also affected so that their capacity to raise external funds for purchasing assets of distressed banks is weakened. Further, we examine the case when asset returns are correlated through securitization. In this case adverse shocks are felt uniformly across the banking sector and banks that survive with the help of a public liquidity backstop will become risk-averse and reluctant to purchase distressed assets. Finally, we explore a government funded asset purchase program, that is implemented with an asset price target. Keywords: Bank runs; Fire sales; Bank liquidity; Banking crises; Local thinking (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:ecofin:v:46:y:2018:i:c:p:89-102 DOI: 10.1016/j.najef.2018.04.001 Access Statistics for this article The North American Journal of Economics and Finance is currently edited by Hamid Beladi More articles in The North American Journal of Economics and Finance from Elsevier |
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