Illiquidity and Under-Valuation of Firms
AbstractWe study a competitive model in which debt-financed firms may default in some states of nature. Incomplete markets prevent firms from hedging the risk of asset firesales when markets are illiquid. This is the only friction in the model and the only cost of default. The anticipation of such losses alone may distort firms' investment decisions. We characterize the conditions under which competitive equilibria are inefficient and the form the inefficiency takes. We also show that endogenous financial crises may arise as a result of pure sunspot events. Finally, we examine alternative interventions to restore the efficiency of equilibria.
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Bibliographic InfoPaper provided by Department of Economics, University of Venice "Ca' Foscari" in its series Working Papers with number 2008_36.
Date of creation: 2008
Date of revision:
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More information through EDIRC
illiquid markets; default; incomplete markets; price distortions; inefficient investment;
Other versions of this item:
- Douglas Gale & Piero Gottardi, 2009. "Illiquidity and Under-Valuation of Firms," Economics Working Papers ECO2009/38, European University Institute.
- Douglas Gale & Piero Gottardi, 2009. "Illiquidity and Under-Valuation of Firms," CESifo Working Paper Series 2900, CESifo Group Munich.
- Piero Gottardi & Douglas Gale, 2009. "Illiquidity and Under-Valuation of Firms," 2009 Meeting Papers 751, Society for Economic Dynamics.
- D5 - Microeconomics - - General Equilibrium and Disequilibrium
- D8 - Microeconomics - - Information, Knowledge, and Uncertainty
- G1 - Financial Economics - - General Financial Markets
- G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2008-12-01 (All new papers)
- NEP-BEC-2008-12-01 (Business Economics)
- NEP-DGE-2008-12-01 (Dynamic General Equilibrium)
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