A Dynamic Model of Systemic Bank Runs

This paper develops a tractable dynamic model to study bank runs in a financial system, featuring the linkage between bank runs and asset market prices. The model speaks to the evolution of a systemic crisis. In our model economy, there are many banks and they share a common asset market. The interim liquidation value of a bank is endogenous and depends on its asset fundamentals, on the status of other banks and hence the aggregate fire sales in the system, and on the endogenous path-dependent market liquidity condition. We analytically characterize the dynamics of the interplay between market liquidity and bank runs. Our model shows runs-illiquidity traps with two steady-state equilibria and a crisis process consisting of an initial gradual decline followed by a sudden sharp crash in the transitional dynamics. Our theory explains empirical facts and gives new policy implications