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Demand deposit contracts and bank runs with present biased preferences

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  • Kang, Minwook

Abstract

This paper extends the Diamond–Dybvig model of bank runs by incorporating hyperbolic discounting. The main question is how consumers’ myopic decisions affect the possibility of a bank run and the bank’s optimal contract. Under hyperbolic discounting, consumers’ deposit preferences differ from their withdrawal preferences. Therefore, the bank needs to consider two separate preferences when designing the optimal banking contract, making it more difficult to design a run-safe banking contract. This difference in preferences could increase the possibility of a bank run in equilibrium. Although the bank can design a run-proof contract, the ex-ante welfare through banking services will be lower under hyperbolic discounting due to its tighter incentive compatibility constraint.

Suggested Citation

  • Kang, Minwook, 2020. "Demand deposit contracts and bank runs with present biased preferences," Journal of Banking & Finance, Elsevier, vol. 119(C).
    • Handle: RePEc:eee:jbfina:v:119:y:2020:i:c:s0378426620301679
    DOI: 10.1016/j.jbankfin.2020.105901
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    Cited by:

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    3. James Peck & Abolfazi Setayesh, 2023. "Bank Runs and the Optimality of Limited Banking," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 47, pages 100-110, January.

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    More about this item

    Keywords

    Bank runs; Demand deposits; Hyperbolic discounting; Financial fragility; Present bias;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets

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