Sophisticated banking contracts and fragility when withdrawal information is public

I study whether self-fulfilling bank runs can occur when banks use sophisticated contracts and withdrawal decisions are public information. In a finite-agent version of Diamond and Dybvig (1983) with correlated types, I first present an example in which a bank run perfect Bayesian equilibrium exists...

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Bibliographic Details
Published in:Theoretical economics 2024, Vol.19 (1), p.285-324
Main Author: Huang, Xuesong
Format: Article
Language:English
Subjects:
Bank runs
Banking
Banking industry
Bayesian analysis
Blockchain
Contracts
correlated types
D82
D83
Economic theory
Equilibrium
forward induction
G21
Game theory
Induction
Liquidity
public information
sophisticated contracts
Truth
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Summary:I study whether self-fulfilling bank runs can occur when banks use sophisticated contracts and withdrawal decisions are public information. In a finite-agent version of Diamond and Dybvig (1983) with correlated types, I first present an example in which a bank run perfect Bayesian equilibrium exists. However, its existence relies on off-path beliefs that are unreasonable in terms of forward induction. To discipline beliefs, I use forward induction equilibrium (Cho, 1987) as the solution concept. I show that, whenever the allocation rule is strictly incentive compatible, the truth-telling strategy is the unique forward induction equilibrium in the withdrawal game, and no bank run occurs. Therefore, with forward induction, sophisticated contracts can prevent bank runs when there is public information about withdrawal decisions.
ISSN:1555-7561
1933-6837
1555-7561
DOI:10.3982/TE5178