Asset Correlation and Bank Runs

Résumé

We introduce correlation between states of the economy in two regions. Each region is populated by a single bank, which receives agents’ deposits and invests them in a risky productive technology. The productive technology allows the risky asset to offer a higher return if held until maturity. The return of the investment is random and depends on the state of the economy. Depositors in each region can be patient or impatient. They receive some private information about the risky asset fundamentals and they have to decide whether they early withdraw their deposit or wait until the end of the bank contract. The aim is to study how asset correlation and public news about asset fundamentals in the other region affect the ex ante probability of bank run. We show that public news affect the way agents interpret their own information and thus, their optimal strategy. This may occur even when agents cannot move between regions. This device turns to be a powerful mechanism of transmission of local shocks. Correlated fundamentals may also affect the ex ante optimal contract that a bank can offer to depositors. In equilibrium, banks do not fully exploit all the benefits of risk shifting, because this exposes them to higher probability of bank runs. Asset correlation may alleviate or worsen the perceived bank’s propensity to runs.