Title: Bank runs and investment decisions revisited
Description: "We examine how the possibility of a bank run affects the deposit contract offered and the investment decisions made by a competitive bank.  Cooper and Ross (1998) have shown that when the probability of a run is small, the bank will offer a contract that admits a bank-run equilibrium.  We show that, in this case, the bank will chose to hold an amount of liquid reserves exactly equal to what withdrawal demand will be if a run does not occur.  In other words, precautionary or "excess" liquidity will not be held.  This result allows us to determine how the possibility of a bank run affects the level of illiquid investment chosen by a bank.  We show that when the cost of liquidating investment early is high, the level of investment is decreasing in the probability of a run.  However, when liquidation costs are moderate, the level of investment is actually increasing in the probability of a run"--Federal Reserve Bank of Richmond web site.
Subjects: Bank deposits, Bank failures, Mathematical models