Endogenous Value and Financial Fragility
AbstractWe construct a model of valuation to assess the financial fragility of a set of firms in a closed economy. A firm is identified with a possibly infinite random sequence of benefits. Firms with negative benefits in a given period are said to be in distress and need liquidity to refinance their projects. Those liquidities must be obtained from firms with positive benefits (which represent excess liquidities). Distressed projects are refinanced to the extent that their need for liquidity does not exceed their endogenous continuation value. This value is, in turn, affected by current and future refinancing possibilities. We provide a recursive procedure to compute this value when there is an aggregate liquidity constraint. We compare the allocation under a centralized coalition of firms with that of a decentralized competitive liquidity market. We show that the competitive market is more fragile because it does not value the possibility that a currently distressed firm could become a provider of liquidity some period in the future. That is, the market value of a firm candiverge from its social value due to externalities involving the ability of that firm to refinance other distressed firms in the future.
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Bibliographic InfoPaper provided by Université Laval - Département d'économique in its series Cahiers de recherche with number 0306.
Date of creation: 2003
Date of revision:
Financial fragility; Liquidity constraints; value; bankruptcy;
Other versions of this item:
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
- G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
- C62 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Existence and Stability Conditions of Equilibrium
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- Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
- den Haan, Wouter J. & Ramey, Garey & Watson, Joel, 2000.
"Liquidity Flows and Fragility of business Enterprises,"
University of California at San Diego, Economics Working Paper Series
qt3d899423, Department of Economics, UC San Diego.
- den Haan, Wouter J. & Ramey, Garey & Watson, Joel, 2003. "Liquidity flows and fragility of business enterprises," Journal of Monetary Economics, Elsevier, vol. 50(6), pages 1215-1241, September.
- Wouter J. den Haan & Garey Ramey & Joel Watson, 1999. "Liquidity Flows and Fragility of Business Enterprises," Cowles Foundation Discussion Papers 1215, Cowles Foundation for Research in Economics, Yale University.
- Wouter den Haan & Garey Ramey & Joel Watson, 1999. "Liquidity Flows and Fragility of Business Enterprises," NBER Working Papers 7057, National Bureau of Economic Research, Inc.
- den Haan, Wouter J. & Ramey, Garey & Watson, Joel, 2000. "Liquidity Flows and Fragility of Business Enterprises," University of California at San Diego, Economics Working Paper Series qt2kc182ts, Department of Economics, UC San Diego.
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