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Coordination Risk and the Price of Debt

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Creditors of a distressed borrower face a coordination problem. Even if the fundamentals are sound, fear of premature foreclosure by others may lead to pre-emptive action, undermining the project. Recognition of this problem lies behind corporate bankruptcy provisions across the world, and it has been identified as a culprit in international financial crises, but has received scant attention from the literature on debt pricing. Without common knowledge of fundamentals, the incidence of failure is uniquely determined provided that private information is precise enough. This affords a way to price the coordination failure. Comparative statics on the unique equilibrium provides several insights on the role of information and the incidence of inefficient liquidation.

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File URL: http://cowles.econ.yale.edu/P/cd/d12a/d1241-r.pdf
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Paper provided by Cowles Foundation for Research in Economics, Yale University in its series Cowles Foundation Discussion Papers with number 1241R.

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Length: 28 pages
Date of creation: Dec 1999
Date of revision: Feb 2002
Publication status: Published in European Economic Review (2004), 48(1): 133-153
Handle: RePEc:cwl:cwldpp:1241r

Note: CFP 1128.
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Keywords: Common knowledge; debt pricing; credit risk; default;

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