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

Vinicius Carrasco and Pablo Salgado

Journal of Financial Intermediation, 2014, vol. 23, issue 1, 129-139

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.

Keywords: Costly state verification; Multiple equilibria; Coordinated default; Full implementation (search for similar items in EconPapers)
Date: 2014
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Citations: View citations in EconPapers (10)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinin:v:23:y:2014:i:1:p:129-139

DOI: 10.1016/j.jfi.2013.06.001

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