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Coordinated strategic defaults and financial fragility in a costly state verification model

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  • Carrasco, Vinicius
  • Salgado, Pablo

Abstract

Diversification through a financial intermediary has the benefit of transforming loans that need costly monitoring into bank deposits that do not. We show that financial intermediation in a costly state verification model has a cost not yet analyzed: it allows for the existence of multiple equilibria, some of which are characterized by borrowers defaulting on their loans because they expect other borrowers to do the same (i.e. bad equilibria arise due to strategic complementarities in entrepreneurs’ actions). We propose two mechanisms that fully implement the desired equilibrium allocation.

Suggested Citation

  • Carrasco, Vinicius & Salgado, Pablo, 2014. "Coordinated strategic defaults and financial fragility in a costly state verification model," Journal of Financial Intermediation, Elsevier, vol. 23(1), pages 129-139.
  • Handle: RePEc:eee:jfinin:v:23:y:2014:i:1:p:129-139
    DOI: 10.1016/j.jfi.2013.06.001
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    References listed on IDEAS

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    Cited by:

    1. Ricardo Serrano-Padial & Lukasz Drozd, 2015. "Financial Contracting with Enforcement Externalities," 2015 Meeting Papers 1362, Society for Economic Dynamics.
    2. Drozd, Lukasz A. & Serrano-Padial, Ricardo, 2017. "Credit Enforcement Cycles," Working Papers 17-27, Federal Reserve Bank of Philadelphia.
    3. repec:bis:bisifc:45-08 is not listed on IDEAS
    4. Fabio Schiantarelli & Massimiliano Stacchini & Philip E. Strahan, 2016. "Bank Quality, Judicial Efficiency and Borrower Runs: Loan Repayment Delays in Italy," NBER Working Papers 22034, National Bureau of Economic Research, Inc.

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