Dynamic Bank Runs
by Zhiguo He University of Chicago, and
March 25, 2009
Abstract: We develop a dynamic model of bank runs. A bank finances its long-term investment by rolling over short-term debts with a continuum of creditors, whose contract periods are staggered. In deciding whether to roll over the debt, each creditor faces the future rollover risk of the bank with other creditors, i.e., the bank fundamental could fall during his contract period, causing other maturing creditors to run and thus forcing the bank to liquidate its asset prematurely at a fire sale price. In contrast to the static bank-run models with self-fulfilling multiple equilibria, we derive a unique monotone equilibrium, in which the creditors coordinate their asynchronous rollover decisions based on the publicly observable time-varying bank fundamental. A preemptive bank run occurs through a rat race among the creditors in choosing higher and higher fundamental thresholds for rolling over their debts. Our model captures a central element of the recent financial crisis--even in the absence of any fundamental deterioration, small changes in the volatility and liquidation value of the bank asset could trigger preemptive runs by creditors on a solvent bank. Our model also provides a useful framework to incorporate rollover risk as an additional source of credit risk.
Related reading: Illiquidity Component of Credit Risk