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Can Cross-Border Financial Markets Create Endogenously Good Collateral in a Crisis?

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Author Info

  • Makoto Saito

    (Professor, Faculty of Economics, Hitotsubashi University, 2-1, Naka, Kunitachi, Tokyo, 186-8601, Japan, phone: +81-42- 580-8807, fax: +81-42-580-8882 (E-mail: makoto@econ.hit-u.ac.jp))

  • Shiba Suzuki

    (Assistant Professor, Faculty of Economics, Meisei University)

  • Tomoaki Yamada

    (Associate Professor, School of Commerce, Meiji University)

Abstract

In this paper, we explore whether markets can create endogenously good collateral in a crisis by analyzing a simple exchange economy where a country-specific catastrophic shock is shared between two countries. To see this possibility, we examine whether the equilibrium achieved by the time-0 complete markets with solvency constraints can be recovered in the dynamically complete markets with collateral constraints. This paper demonstrates that it is possible to recover the time-0 equilibrium outcome in a sequential manner when pricing errors occur randomly in evaluating Lucas trees at a catastrophic event. Such stochastic components may be interpreted as a policy initiative to create good collateral and yield constrained efficient outcomes at crisis periods.

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Bibliographic Info

Paper provided by Institute for Monetary and Economic Studies, Bank of Japan in its series IMES Discussion Paper Series with number 10-E-19.

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Date of creation: Aug 2010
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Handle: RePEc:ime:imedps:10-e-19

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Related research

Keywords: Solvency Constraints; Collateral Constraints; Dynamic Optimal Contract; Catastrophic Shocks;

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Cited by:
  1. Shigenori Shiratsuka & Wataru Takahashi & Yuki Teranishi & Kozo Ueda, 2010. "Future of Central Banking under Globalization: Summary of the 2010 International Conference Organized by the Institute for Monetary and Economic Studies of the Bank of Japan," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 28, pages 1-16, November.

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