Liquidity Runs

Tinbergen Institute Discussion Paper 16-087/IV

35 Pages Posted: 19 Oct 2016

See all articles by Rafael Matta

Rafael Matta

SKEMA Business School - Université Côte d'Azur

Enrico C. Perotti

University of Amsterdam - Finance Group; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: October 18, 2016

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.

Keywords: liquidity risk, bank runs, global games, demandable debt, mandatory stay

JEL Classification: G21

Suggested Citation

Matta, Rafael and Perotti, Enrico C., Liquidity Runs (October 18, 2016). Tinbergen Institute Discussion Paper 16-087/IV, Available at SSRN: https://ssrn.com/abstract=2854145 or http://dx.doi.org/10.2139/ssrn.2854145

Rafael Matta (Contact Author)

SKEMA Business School - Université Côte d'Azur ( email )

60 rue Dostoïevski
Sophia Antipolis, 06902
France

HOME PAGE: http://https://sites.google.com/site/almeidadamatta/

Enrico C. Perotti

University of Amsterdam - Finance Group ( email )

Plantage Muidergracht 12
Amsterdam, 1018 TV
Netherlands
+31 20 525 4159 (Phone)
+31 20 525 5285 (Fax)

HOME PAGE: http://www.fee.uva.nl/fm/people/pero.htm

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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