Modeling Guarantees, Over-Indebtedness and Financial Crises in an Open Economy

Germana Corrado

International Economic Journal, 2011, vol. 25, issue 1, 147-172

Abstract: This work develops a simple framework to analyse how financial intermediaries' balance sheet problems combined with financial guarantees make an economy more vulnerable to financial crises. A 'double default' problem - that is, the default of financial intermediaries on their debt repayments and of the government on its guarantees to bailout intermediaries' losses - is modelled in this study. The possibility of multiple equilibria, including a crisis equilibrium where the government is not able or willing to honor its guarantees towards the domestic financial sector, arises from the interplay of all the above elements: financial intermediaries' level of indebtedness, government implicit guarantees and high-risk creditors' lending. This work also produces predictions concerning the vulnerability to a financial crisis: multiple equilibria are possible only in certain ranges of the fundamentals.

Keywords: Financial guarantees; risk premium; multiple equilibria (search for similar items in EconPapers)
Date: 2011
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Persistent link: https://EconPapers.repec.org/RePEc:taf:intecj:v:25:y:2011:i:1:p:147-172

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DOI: 10.1080/10168737.2010.487542

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