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Bank runs and investment decisions revisited

Huberto Ennis () and Todd Keister ()

No 04-03, Working Paper from Federal Reserve Bank of Richmond

Abstract: We examine how the possibility of a bank run affects the deposit contract offered and the investment decisions made by a competitive bank. Cooper and Ross (1998) have shown that when the probability of a run is small, the bank will offer a contract that admits a bank-run equilibrium. We show that, in this case, the bank will chose to hold an amount of liquid reserves exactly equal to what withdrawal demand will be if a run does not occur. In other words, precautionary or \"excess\" liquidity will not be held. This result allows us to determine how the possibility of a bank run affects the level of illiquid investment chosen by a bank. We show that when the cost of liquidating investment early is high, the level of investment is decreasing in the probability of a run. However, when liquidation costs are moderate, the level of investment is actually increasing in the probability of a run.

Date: 2004
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Journal Article: Bank runs and investment decisions revisited (2006) Downloads
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