There is little or no probability of bank insolvency, type one depositors may prefer to follow type two depositors and leave their deposit for a longer period of time. Because they would like to take advantage of the higher return on the bank's assets and the expected higher investment return compensates for their impatience. Therefore, when the probability of bank insolvency is low (based on economic fundamentals), impatient depositors can act as patient depositors and the bank will liquidate the funds at the end of the maturity and divide the proceeds equally among the depositors. plagiarism. Get a tailor-made essay on "Why Violent Video Games Shouldn't Be Banned"? Get Original Essay But the bank faces a severe liquidity crisis when type two depositors pretend to behave like type one and ask for early withdrawal. This situation occurs when depositors receive signals that economic fundamentals are bad and their bank's performance correlates with that of other insolvent banks in the previous year. They become convinced that the probability of bank insolvency is high and that type two depositors would prefer to withdraw early. Because in the event of insolvency, the bank may not differentiate depositors based on their state of patience and satisfy liquidity requests on a first-come, first-served basis. As both patient and impatient depositors attempt to withdraw their deposits, the bank begins to rapidly lose its reserves and leads to capitulation. The bank run in this case is caused by factors that are not directly related to the bank's financial activities and sometimes the bank faces a bank run due to a sudden liquidity shock even if it is not insolvent. Bougheas (1999) introduced the OLG model instead of OLG framework because he wants to eliminate any discrimination between informed and uninformed depositors. Thus, there will be less chance of drawing biased conclusions. Depositors in the OLG model will only follow changes in economic fundamentals and their perception about the correlation between bank returns. At the end of his theory the researcher drew two main conclusions. The first conclusion is that in an unregulated banking environment, bank runs can only be contagious if the economic situation is negative (recession). The likelihood that a bank run will lead to a run on other solvent banks does not actually imply that the current banking system is unstable. But the second conclusion states that a run on the banks of a single bank may not cause contagion but certainly spread a negative signal on macroeconomic stability. So, this negative signal may cause some financial turbulence to other banks such as liquidity shortage, which may ultimately lead to insolvency. Panic Bank RunDiamond and Dybvig (1983) (D&D model) presented the demand deposit contract that exposes the bank to panic banking. run. Unfortunately, they have not given us a precise mechanism for determining the likelihood of a bank run or the consequences of the run on aggregate economic welfare. Itay Goldstein and Ady Pauzner (2005) conducted scientific research on a modified version of the D&D model, in which they also embrace the idea of ​​economic fundamentals but not as determinants of bank runs. Economic fundamentals are used as a mechanism to coordinate depositors' beliefs about a certain outcome. They also consider the situation where depositors acquire private signals and as suchsignals shape their perception of a plausible bank run. Their modified D&D model also explores the underlying causality between the optimal level of short-term payment to impatient depositors, risk sharing (demand deposit contracts), and bank run efficiency. Here, we will understand the panic-based bank run theory, where researchers (Goldstein & Pauzner, 2005) explain the welfare gain or loss due to bank runs and according to them the run is not necessarily caused by inexplicable feelings of depositors . They also propose some regulatory measures, which could be useful to eliminate or at least minimize the probability of bank runs and the moral hazard problem regarding deposit contracts. But we will analyze regulatory intervention policies in different circumstances in the final part of this scientific article. We will follow the scientific work of Goldstein & Pauzner (2005). Let's start with a brief summary of the traditional D&D model. The traditional demand deposit model (D&D model) was proposed by Diamond & Dybvig (1983), where researchers explained that demand deposit contracts offered by banks are very useful for providing liquidity but at the same time these contracts expose banks to the possibility of a panic-based run. In short, D&D contracts allow banks to create liquid claims on long-term illiquid assets, but due to the maturity mismatch problem between assets (loans) and liabilities (deposits) banks become vulnerable to the probability of a bank based on panic. run. The D&D model has two equilibria. In case of good balance, only impatient depositors (even short-term investors) require early withdrawal of the deposit. To satisfy their impatience, they are offered more than the liquidation value of the asset in the long term, which results in welfare improvement in the risk-sharing situation. But in case of bank run, bad equilibrium occurs. In a bad equilibrium, both impatient and patient depositors will demand early withdrawal of deposits, which will eventually lead to a bank run (liquidity shock) and result in a loss of welfare. But the problem with the traditional D&D model is that it doesn't provide us with the mechanism required to anticipate which type of equilibrium will occur or how to derive the probability of each equilibrium occurring. There are several early scientific papers that worked on panic-based systems. bank runs but from different perspectives. Chari and Jagannathan (1988) presented panic-based bank runs caused by uninformed depositors. They have shown that uninformed agents misinterpret economic fundamentals (based on the run of other agents) and have triggered panic attacks. On the other hand, Peck and Shell (2003) explored the idea of ​​more flexible deposit contracts, which could lead to the complete elimination of bank runs. According to Peck and Shell, under these contracts, the bank will be able to formulate payment for early depositors (impatient depositors) to stop the contagion. But due to the moral hazard problem, these contracts should not be allowed, we will discuss this later in this article. Goldstein and Pauzner (2005) considered both these scientific works and made the necessary modifications to analyze the interconnectedness of deposit contracts and the probability of bank runs. The researchers also use economic fundamentals in their model, but not like Bougheas (1999) as a determining tool of bank runs. They use ifundamental as a tool for understanding depositor behavior and bank runs are still based on panic as in the traditional D&D model. In this model, economic fundamentals are stochastic and depositors have no common knowledge of the fundamental status. They prefer to have slightly noisy private signals, which is more likely to be quite realistic. Researchers have also shown that bank runs only occur when economic fundamentals are below a certain critical value. But according to this theory, bank runs are still based on bad expectations. Depositors will take any action (stay or run away) based on his belief that others will do the same. Thus, one custodian may run simply because it assumes that the other would also run, even when economic fundamentals are sufficiently strong. The traditional D&D model explains that there are two equilibria, in a good equilibrium the bank increases welfare and in a bad equilibrium it decreases welfare. To resolve the difficulty regarding well-being and balance, Goldstein and Pauzner (2005) follow the scientific works of Carlsson and van Damme (1993) and Morris and Shin (1998). In both of these articles (also in current theory) they showed that if depositors receive noisy signals and formulate their actions based on them, this accident can lead to a unique equilibrium. This unique balance can be explained by the assumption of global strategic complementarities. Global strategic complementarities (GSC) represent a situation in which a depositor's motivation to pursue early withdrawal increases steadily with the number of other depositors pursuing the same action. Thus, according to GSC, the motivation to rush is greatest not when all depositors do so, but when the aggregate demand for early withdrawals reaches the bankruptcy level. But beyond this level the incentives for early withdrawal may not increase with the number of additional depositors requesting early withdrawal. According to Goldstein and Pauzner (2005) once the bank exhausts its liquid reserve and due to asset sell-offs leads to insolvency, the probability of obtaining compensation from the bank decreases dramatically. This unique situation is called unilateral strategic complementarity (OSC). OSC represents a situation in which depositors prefer to stay rather than run away as long as the number of early depositors is relatively small. So, this is how researchers explain the unique behavior of depositors in the panic rush according to the modified D&D model (Goldstein & Pauzner, 2005). The researchers also explore the relationship between the degree of risk sharing and the probability of bank runs. find the optimal level of payment in the short term. They showed that a bank becomes more exposed to bank runs when it offers higher short-term payments. For an efficient bank run to occur, the short-term aggregate payment must equal the liquidation value of the long-term asset. Since in this particular situation the bank run occurs only when the expected long-term return is substantially low, depositors can obtain a better return if the long-term asset is liquidated early. On the other hand, if the bank offers a short-term return that is higher than the liquidation value of its long-term asset, it may face an inefficient bank run. Because if a bank run occurs, the bank will have to sell its long-term assets, even if their long-term yield is substantially high.So, the final question is how does a bank formulate a deposit contract with an optimal level of risk sharing to minimize the probability of bank runs and increase welfare? We will explore this question in two different situations where depositors have no private signals and in another situation where depositors acquire some private information. The bank offers impatient depositors a deposit contract with short-term payments in order to meet their consumption needs. Furthermore, due to the high degree of risk aversion, the bank must offer impatient depositors an incentive-compatible deposit contract and thus a wealth transfer from patient to impatient depositors may be preferable. Although this risk sharing could cause some long-term assets to be liquidated early. But the types of depositors are private information, unknown to the bank. Therefore, the bank cannot formulate payments based on their type. So, they offer demand deposit contracts to allow risk sharing, but in case of short-term payment the bank faces a sequential constraint: equal amount to depositors until its reserve is exhausted. In this condition the researchers discuss two possible equilibria: if only impatient depositors chose early withdrawal, they would receive the payment but there will be less earnings for patient depositors in the future. But if both impatient and patient depositors opt for the advance deposit rush, there will be nothing left to gain in the future. So agents would opt to require early withdrawal and cause an unproductive equilibrium. According to the traditional D&D model, the optimal short-term payout is achieved by assuming that the good balance will always be preferred by depositors. But evidently the balance is not always good and risk sharing may not always be preferable. Furthermore, it is difficult to quantify the relationship between the quality of banking contracts and the probability of a bank run. This situation brings us to the discussion of unique equilibrium, where depositors receive private signals. Goldstein and Pauzner (2005) modified the traditional D&D model by introducing private signals into the equilibrium. With this modified model, each depositor receives a private signal on economic fundamentals and formulates their actions based on this signal. An agent's private signal can be thought of as his private assessment of the probability of long-term earnings. These private signals are idiosyncratic in nature and none of the depositors has any dominance over the others regarding the quality of information. The lack of completeness in the private signal makes it more difficult for a depositor to calculate his expected profit, so he largely depends on his private signal to articulate his actions. Private signals allow depositors to formulate their decision based on their individual signal. If a depositor receives a higher signal, he will assume that the probability of obtaining a long-term return on illiquid assets is also high. Therefore, she feels less motivated to request early withdrawal. Furthermore, this private signal also serves as an indicator of other agents' signals. If a depositor experiences that other agents are also receiving a high signal, he develops the belief that others will not run away too and this leads to even less motivation to run the bank. Researchers assume that there are two extreme cases of economic fundamentals. In both cases (extremely positive and extremely negative), the actions of the agents are influenced to a great extent.