Bailouts and bank runs: Theory and evidence from TARP

- Found that empirical measure of bank run probability increases after bank bailout announcement (TARP), which contrasts with conventional wisdom.
- Developed a model with a unique bank run equilibrium by employing the global game technique to get rid of Diamond-Dybvig multiple coordination equilibrium.
- Ex ante, bailout reduces bank run probability. Ex post, bailout may increase bank run probability by signaling bad bank fundamental.

During the recent financial crisis, there were bank runs right after government bailout announcements. This paper develops a global game model of information based bank runs to analyze how the announcement of bailouts affects investors' bank run incentives. The equilibrium probability of bank runs is uniquely determined. I conclude that before the announcement, the existence of such bailout policy reduces investors' bank run incentives, but after the announcement, investors may run on the bank, since such an announcement reflects the government's information about the bad bank asset. The empirical evidence from TARP is consistent with my theory.