Paper of Enrico Perotti published in The Review of Financial Studies
The classic view assumes banks prioritize immediate repayment by selling assets until default. We endogenize run frequency and study how general settlement rules trade off liquidity provision net of fire sale losses against induced run incentives. Panic runs are eliminated when all illiquid assets are sold under orderly resolution, but liquidity provision in a run is minimal. When suspension after some fire sales is followed by immediate liquidation, run frequency falls then rises in suspension delay. Thus, optimal suspension may require some sale of illiquid assets, in contrast to MMF norms. Ex post discretion induces excessive liquidation and more frequent runs.
Article citation and access to full article:
Rafael Matta and Enrico Perotti, Pay, Stay, or Delay? How to Settle a Run, The Review of Financial Studies, , published online November 2023, doi.org/10.1093/rfs/hhad084.