assets. This is particularly the case when deposits are insured, because deposit rates are insensitive to banks’ risk exposure.
Runs can be related to panics or arise from fundamentals. As shown by Diamond and Dybvig (1983), panic bank runs are random events linked to self-fulfilling prophecies. Given the assumption of first-come-first-served and the low liquidation value of the long term assets, there are multiple equilibria. If all depositors believe that a panic will not occur, only the consumers in need of early consumption withdraw their funds and their demands are satisfied. In contrast, if depositors believe a crisis will occur, all of them rush to avoid being last in the line. Which of these two equilibria occurs depends on extraneous variables or “sunspots”. Although sunspots have no effect on the real data of the economy, they affect depositors' beliefs in a way that turns out to be self-fulfilling.
The key issue in the panic approach is the equilibrium selection. There is no real account of what triggers a crisis. This is particularly a problem for policy analysis. Ways to get around the multiplicity of equilibria are suggested by Postlewaite and Vives (1987), and, more recently, by Rochet and Vives (2004) and Goldstein and Pauzner (2005), who use the techniques of global games to generate a unique equilibrium.
The fundamental view of bank runs asserts that crises are linked to the business cycle (e.g., Gorton, 1988). When the economy goes into recession, the returns on bank assets will be low. If depositors receive information about the impending downturn, they anticipate banks’ financial difficulties and try to withdraw their funds early. Given their liabilities are fixed, banks may be unable to remain solvent. Thus, crises are a response to unfolding economic circumstances.
Runs may trigger a systemic crisis. The propagation, or contagion, can occur through the interbank market, the payment system or through asset prices. The latter may lead to contagion also across different sectors, as shown in Allen and Carletti (2006, 2008) in a context where markets are incomplete and asset prices are determined by the available liquidity or in other words by the “cash in the market”.