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On sunspots, bank runs, and Glass–Steagall
Author(s) -
Shell Karl,
Zhang Yu
Publication year - 2019
Publication title -
international journal of economic theory
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.351
H-Index - 11
eISSN - 1742-7363
pISSN - 1742-7355
DOI - 10.1111/ijet.12208
Subject(s) - sunspot , economics , constraint (computer aided design) , bank run , fragility , incentive , global game , incentive compatibility , mathematical economics , monetary economics , microeconomics , financial crisis , keynesian economics , physics , mathematics , quantum mechanics , magnetic field , geometry , thermodynamics
We analyze the pre‐deposit game in a two‐depositor banking model. The Glass–Steagall bank is assumed to be restricted to holding only liquid assets. Depositors tolerate a panic‐based run if its probability of occurrence s is small. How s affects the allocation of assets depends on the incentive compatibility constraint (ICC). When the ICC is not binding, the sunspot allocation is not a mere randomization over the run and non‐run outcomes under the so‐called “optimal contract.” We offer this paper as a contribution to both the literature on banking and financial fragility and also the broader literature on sunspot equilibrium.