The Korean Economic Review
Short-Term Debt in International Banking Crises
Eunsook SeoYear 2008Vol. 24No. 1
This paper explores how a bank run can occur when a bank takes into account short-term capital inflow from abroad. My model is an extension of the Diamond-Dybvig model to include the possibility that short-term liquidity needs can be met by borrowing from abroad. In the model, it is more efficient to meet short-term liquidity needs this way than by holding liquid domestic assets. I show conditions under which a “bad” equilibrium exists in which pessimistic foreign investors withhold their investments, making a bank run the equilibrium strategy for domestic agents and making those expectations self-fulfilling.