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Solvency runs, sunspot runs, and international bailouts

  • Mark M. Spiegel

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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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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  1. Xavier Freixas & Bruno Parigi & Jean-Charles Rochet, 2000. "Systemic risk, interbank relations, and liquidity provision by the central bank," Proceedings, Federal Reserve Bank of Cleveland, pages 611-640.
  2. Christopher Sleet & Bruce D. Smith, 2000. "Deposit insurance and lender-of-last-resort functions," Proceedings, Federal Reserve Bank of Cleveland, pages 518-579.
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  7. 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.
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  9. Franklin Allen & Douglas Gale, 1976. "Optimal Financial Crises," Center for Financial Institutions Working Papers 97-01, Wharton School Center for Financial Institutions, University of Pennsylvania.
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  14. 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.
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  18. Douglas Gale & Martin Hellwig, 1985. "Incentive-Compatible Debt Contracts: The One-Period Problem," Review of Economic Studies, Oxford University Press, vol. 52(4), pages 647-663.
  19. Jeanne, Olivier, 2000. "Debt Maturity and the Global Financial Architecture," CEPR Discussion Papers 2520, C.E.P.R. Discussion Papers.
  20. Ilan Goldfajn & Rodrigo O. Valdes, 1997. "Capital Flows and the Twin Crises; The Role of Liquidity," IMF Working Papers 97/87, International Monetary Fund.
  21. Boyd, John H. & Smith, Bruce D., 1999. "The Use of Debt and Equity in Optimal Financial Contracts," Journal of Financial Intermediation, Elsevier, vol. 8(4), pages 270-316, October.
  22. 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.
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