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Solvency runs, sunspot runs, and international bailouts

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  • Mark M. Spiegel

Abstract

This paper introduces a model of international lender of last resort (ILLR) activity under asymmetric information. The ILLR is unable to distinguish between runs due to debtor insolvency and those which are the result of pure sunspots. Nevertheless, the ILLR can elicit the underlying state of nature from informed creditors by offering terms consistent with generating a separating equilibrium. Achieving the separating equilibrium requires that the ILLR lends to the debtor at sufficiently high rates. This adverse electing problem provides an alternative rationale for Bagehot's Principle of last-resort lending at high rates of interest to the moral hazard motivation commonly found in the literature.

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Bibliographic Info

Paper provided by Federal Reserve Bank of San Francisco in its series Working Paper Series with number 2001-05.

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Date of creation: 2000
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Publication status: Published in Journal of International Economics, v. 65, no. 1 (January 2005) pp. 203-219
Handle: RePEc:fip:fedfwp:2001-05

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Keywords: Financial crises ; Lenders of last resort ; Debt;

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References

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  1. Gale, Douglas & Hellwig, Martin, 1985. "Incentive-Compatible Debt Contracts: The One-Period Problem," Review of Economic Studies, Wiley Blackwell, vol. 52(4), pages 647-63, October.
  2. Roberto Chang & Andres Velasco, 1999. "Liquidity crises in emerging markets: Theory and policy," Working Paper 99-15, Federal Reserve Bank of Atlanta.
  3. Chang, Roberto & Velasco, Andres, 2000. "Banks, debt maturity and financial crises," Journal of International Economics, Elsevier, vol. 51(1), pages 169-194, June.
  4. Allen N. Berger & Sally M. Davies & Mark J. Flannery, 2000. "Comparing market and supervisory assessments of bank performance: who knows what when?," Proceedings, Federal Reserve Bank of Cleveland, pages 641-670.
  5. Andrew K. Rose & Mark M. Spiegel, 2004. "A Gravity Model of Sovereign Lending: Trade, Default, and Credit," IMF Staff Papers, Palgrave Macmillan, vol. 51(s1), pages 50-63, June.
  6. Oliver Hart & John Moore, 1997. "Default and Renegotiation: A Dynamic Model of Debt," NBER Working Papers 5907, National Bureau of Economic Research, Inc.
  7. Freixas, Xavier & Parigi, Bruno M & Rochet, Jean-Charles, 2000. "Systemic Risk, Interbank Relations, and Liquidity Provision by the Central Bank," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(3), pages 611-38, August.
  8. Spiegel, Mark M, 1992. "Concerted Lending: Did Large Banks Bear the Burden?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 24(4), pages 465-82, November.
  9. Haizhou Huang & C. A. E. Goodhart, 2000. "A Simple Model of An International Lender of Last Resort," IMF Working Papers 00/75, International Monetary Fund.
  10. Chari, V V & Jagannathan, Ravi, 1988. " Banking Panics, Information, and Rational Expectations Equilibrium," Journal of Finance, American Finance Association, vol. 43(3), pages 749-61, July.
  11. Jeanne, Olivier, 2000. "Debt Maturity and the Global Financial Architecture," CEPR Discussion Papers 2520, C.E.P.R. Discussion Papers.
  12. Ilan Goldfajn & Rodrigo O. Valdés, 1997. "Capital Flows and the Twin Crises," IMF Working Papers 97/87, International Monetary Fund.
  13. Franklin Allen & Douglas Gale, 1998. "Optimal Financial Crises," Journal of Finance, American Finance Association, vol. 53(4), pages 1245-1284, 08.
  14. Marchesi, Silvia & Thomas, Jonathan P, 1999. "IMF Conditionality as a Screening Device," Economic Journal, Royal Economic Society, vol. 109(454), pages C111-25, March.
  15. Charles Goodhart, 1999. "Myths About the Lender of Last Resort," FMG Special Papers sp120, Financial Markets Group.
  16. Philippe Aghion, Patrick Bolton & Steven Fries, 1999. "Optimal Design of Bank Bailouts: The Case of Transition Economies," Journal of Institutional and Theoretical Economics (JITE), Mohr Siebeck, Tübingen, vol. 155(1), pages 51-, March.
  17. Jacklin, Charles J & Bhattacharya, Sudipto, 1988. "Distinguishing Panics and Information-Based Bank Runs: Welfare and Policy Implications," Journal of Political Economy, University of Chicago Press, vol. 96(3), pages 568-92, June.
  18. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June.
  19. Haibin Zhu, 2001. "Bank runs without self-fulfilling prophecies," BIS Working Papers 106, Bank for International Settlements.
  20. John H. Boyd & Bruce D. Smith, 1996. "The use of debt and equity in optimal financial contracts," Working Papers 537, Federal Reserve Bank of Minneapolis.
  21. Sleet, Christopher & Smith, Bruce D, 2000. "Deposit Insurance and Lender-of-Last-Resort Functions," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(3), pages 518-75, August.
  22. Alonso, Irasema, 1996. "On avoiding bank runs," Journal of Monetary Economics, Elsevier, vol. 37(1), pages 73-87, February.
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  24. Manmohan S. Kumar & Paul R. Masson & Marcus Miller, 2000. "Global Financial Crises," IMF Working Papers 00/105, International Monetary Fund.
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Citations

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Cited by:
  1. Andrew K. Rose & Mark M. Spiegel, 2009. "Noneconomic Engagement and International Exchange: The Case of Environmental Treaties," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(2-3), pages 337-363, 03.
  2. Misa Tanaka, 2005. "Bank loans versus bond finance: implications for sovereign debtors," Bank of England working papers 267, Bank of England.
  3. Cecile Bastidon & Philippe Gilles & Nicolas Huchet, 2008. "A Selective Bail-Out International Lending of Last Resort Model," Annals of Economics and Finance, Society for AEF, vol. 9(1), pages 103-114, May.

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