Capital Structure, Liquidity and Miscoordination on Runs

Abstract

We analyze miscoordination on runs among debt investors under changing capital structure and market liquidity of firm assets. Investors draw on a finite, common pool of liquidity. In case of a run, repay to debt investors is partial and endogenous. The resulting global game with one-sided strategic complementarity gives rise to non-monotone comparative statics. When liquidity dries up, increasing short-term financing may decrease the probability of runs, more short-term debt can discipline debt investors to better coordinate. As a result, capital and liquidity regulation may harm stability. Results hold under partial asset liquidation or collateralized borrowing.

Keywords: bank runs, coordination, global games, strategic complementarity, financial stability, capital structure, leverage, liquidity, financial regulation

JEL Classification: D82, G21, G28