A Bank Panic Model with a Bond Market

Abstract

We have constructed a model of bank failure with monetary assets (bonds), adopting the overlapping-generations model. In it, monetary assets play a role in dispersing the credit crunch from a single bank run into a nationwide bank panic. As established by Diamond and Dybvig (1983), a single bank run is explained by a model without any monetary assets. In our model, however, the bond market is introduced to describe the process in which a bank run spreads. As a result, our model describes a general phenomenonÐcredit market failureÐrather than a single bank run. JEL classi®cation numbers: G21, E40.