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

Makoto Saito, Shiba Suzuki and Tomoaki Yamada

No 10-E-19, IMES Discussion Paper Series from Institute for Monetary and Economic Studies, Bank of Japan

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.

Keywords: Solvency Constraints; Collateral Constraints; Dynamic Optimal Contract; Catastrophic Shocks (search for similar items in EconPapers)
JEL-codes: F34 G12 G15 (search for similar items in EconPapers)
Date: 2010-08
New Economics Papers: this item is included in nep-dge, nep-ifn and nep-opm
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:ime:imedps:10-e-19

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