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Liquidity Runs

Author

Listed:
  • Perotti, Enrico
  • Matta, Rafael

Abstract

Can the risk of losses upon premature liquidation produce bank runs? We show how a unique run equilibrium driven by asset liquidity risk arises even under minimal fundamental risk. To study the role of illiquidity we introduce realistic norms on bank default, such that mandatory stay is triggered before all illiquid assets are sold. Since illiquid assets are not available in a run, asset liquidity risk has a concave effect on run incentives, quite unlike fundamental risk. Runs are rare when asset liquidity is abundant, become more frequent as it falls and decrease again under very low asset liquidity. The socially optimal demandable debt contract limits inessential runs by targeting a high rollover yield. However, the private choice minimizes funding costs, tolerating more frequent runs when illiquid states are sufficiently rare.

Suggested Citation

  • Perotti, Enrico & Matta, Rafael, 2016. "Liquidity Runs," CEPR Discussion Papers 11481, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:11481
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    References listed on IDEAS

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    1. Markus K. Brunnermeier & Lasse Heje Pedersen, 2009. "Market Liquidity and Funding Liquidity," The Review of Financial Studies, Society for Financial Studies, vol. 22(6), pages 2201-2238, June.
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    Cited by:

    1. Ahnert, Toni & Anand, Kartik & Gai, Prasanna & Chapman, James, 2015. "Safe, or not safe? Covered bonds and Bank Fragility," VfS Annual Conference 2015 (Muenster): Economic Development - Theory and Policy 112875, Verein für Socialpolitik / German Economic Association.
    2. Schilling, Linda, 2017. "Optimal Forbearance of Bank Resolution," MPRA Paper 112409, University Library of Munich, Germany.
    3. Toni Ahnert & Kartik Anand & Prasanna Gai & James Chapman & Philip StrahanEditor, 2019. "Asset Encumbrance, Bank Funding, and Fragility," The Review of Financial Studies, Society for Financial Studies, vol. 32(6), pages 2422-2455.
    4. Linda Schilling, 2018. "Optimal Forbearance of Bank Resolution," Working Papers 2018-15, Becker Friedman Institute for Research In Economics.

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    More about this item

    Keywords

    Liquidity risk; Bank runs; Global games; Demandable debt; Mandatory stay;
    All these keywords.

    JEL classification:

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

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