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Capital Inflows and Bank Runs

  • Journal of Insurance and Finance
  • 2011, 22(3), pp.95-125
  • Publisher : Korea Insurance Research Institute
  • Research Area : Social Science > Business Management

서은숙 1

1상명대학교

Accredited

ABSTRACT

This paper focuses on the design of banking arrangements in an open economy, where banks, but not private agents, have access to short-term foreign debt. This study shows that when the possibility of bank runs are not considered, the bank's portfolio at the beginning of a period is more illiquid than in the baseline closed economy case. Then I ask a mechanism design question: What is the optimal contract in the presence of the possibility of a sunspot-triggered bank runs? I show that when international financial markets are in equilibrium, it is always optimal for the bank to choose a run-preventing contract. To do so, the bank must hold excess liquid assets, the source of which is foreign borrowing.

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