Moral hazard, bank runs and contagion

S. Chatterji and Sayantan Ghosal

No 269785, Economic Research Papers from University of Warwick - Department of Economics

Abstract: We study banking with ex ante moral hazard. Resolving the misalignment of the incentives between banks and depositors requires early liquidation with positive probability: e¢cient risk-sharing between depositors is no longer implementable. In a closed region with a single bank, we show that (i) with costless and perfect monitoring, contracts with bank runs o¤ the equilibrium path of play improve on contracts with transfers, (ii) when the bank’s actions are non-contractible, equilibrium bank runs driven by incentives are linked to liquidity provision by banks. With multiple regions linked via an interbank market, with local moral hazard, we show that implementing second-best allocations requires both ex-ante trade in inter-bank markets and contagion after realization of liquidity shocks.

Keywords: Financial Economics; Risk and Uncertainty (search for similar items in EconPapers)
Pages: 28
Date: 2008-01-13
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Working Paper: Moral hazard, bank runs and contagion (2008)
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Persistent link: https://EconPapers.repec.org/RePEc:ags:uwarer:269785

DOI: 10.22004/ag.econ.269785

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