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Bank runs, portfolio choice, and liquidity provision

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  • Ahnert, Toni
  • Elamin, Mahmoud

Abstract

We examine the portfolio choice of banks in a micro-founded model of runs. To insure risk-averse investors against liquidity risk, competitive banks offer demand deposits. We use global games to link the probability of a run to the bank's portfolio management. Based upon interim information about risky investment, banks liquidate investments to hold a safe asset. This partial hedge against investment risk reduces the withdrawal incentives of investors for a given deposit rate. As a result, (i) banks provide more liquidity ex ante (so banks offer a higher deposit rate) and (ii) the welfare of investors increases. Our results highlight the management of both sides of a bank's balance sheet and a complementarity in the two forms of insurance that banks provide to investors.

Suggested Citation

  • Ahnert, Toni & Elamin, Mahmoud, 2020. "Bank runs, portfolio choice, and liquidity provision," Journal of Financial Stability, Elsevier, vol. 50(C).
    • Handle: RePEc:eee:finsta:v:50:y:2020:i:c:s1572308920300802
    DOI: 10.1016/j.jfs.2020.100781
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    More about this item

    Keywords

    Global games; Portfolio choice; Investment risk; Demand deposits; Liquidity provision; Bank runs;
    All these keywords.

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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