Demand deposit contracts and bank runs with present biased preferences

This paper extends the Diamond–Dybvig model of bank runs by incorporating hyperbolic discounting. The main question is how consumers’ myopic decisions affect the possibility of a bank run and the bank's optimal contract. Under hyperbolic discounting, consumers’ deposit preferences differ from their withdrawal preferences. Therefore, the bank needs to consider two separate preferences when designing the optimal banking contract, making it more difficult to design a run-safe banking contract. This difference in preferences could increase the possibility of a bank run in equilibrium. Although the bank can design a run-proof contract, the ex-ante welfare through banking services will be lower under hyperbolic discounting due to its tighter incentive compatibility constraint.