We analyze a banking system in which the class of feasible deposit contracts, or mechanisms, is broad. The mechanisms must satisfy a sequential service constraint, but partial or full suspension of convertibility is allowed. Consumers must be willing to deposit, ex ante. We show, by examples, that under the so-called "optimal contract," the post-deposit game can have a run equilibrium. Given a "propensity" to run, triggered by sunspots, the optimal contract for the full pre-deposit game can be consistent with runs that occur with positive probability. Thus, the Diamond-Dybvig framework can explain bank runs, as emerging in equilibrium under the optimal deposit contract.
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Paper provided by Cornell University, Center for Analytic Economics in its series Working Papers with number
01-10r.
Find related papers by JEL classification: D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Mortgages
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