Optimal financial crises

Franklin Allen, Douglas Gale

    Research output: Contribution to journalArticle

    Abstract

    Empirical evidence suggests that banking panics are related to the business cycle and are not simply the result of "sunspots." Panics occur when depositors perceive that the returns on bank assets are going to be unusually low. We develop a simple model of this. In this setting, bank runs can be first-best efficient: they allow efficient risk sharing between early and late withdrawing depositors and they allow banks to hold efficient portfolios. However, if costly runs or markets for risky assets are introduced, central bank intervention of the right kind can lead to a Pareto improvement in welfare.

    Original languageEnglish (US)
    Pages (from-to)1245-1284
    Number of pages40
    JournalJournal of Finance
    Volume53
    Issue number4
    DOIs
    StatePublished - Aug 1998

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    ASJC Scopus subject areas

    • Accounting
    • Finance
    • Economics and Econometrics

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