Investment Complementarities, Coordination Failure And Systemic Bankruptcy

Mei Li

No 1149, Working Paper from Economics Department, Queen's University

Abstract: I argue that systemic bankruptcy of firms can originate from coordination failure in an economy with investment complementarities. This new explanation about the origin of systemic bankruptcy promotes better understanding of how financial fragility arises, and provides theoretical guidance for central banks to establish an "early warning system" to prevent the occurrence of financial crises. In a global game setup, investment decisions of firms are studied in the presence of uncertainty and investment complementarities. Uncertainty is twofold here: first, firms are uncertain about economic fundamentals; second, firms are also uncertain about other firms' investmentdecisions. I demonstrate that even small uncertainty about economic fundamentalscan be magnified through the uncertainty about other firms' investment decisions and can lead to coordination failure, which may be manifested as systemic bankruptcy. Moreover, my model reveals that systemic bankruptcy tends to arise when economic fundamentals are in the middle range where coordination matters. High financial leverage of firms greatly increases the severity of systemic bankruptcy. Optimistic beliefs of firms and banks can alleviate coordination failure, but can also increase the severity of systemic bankruptcy once it happens.

Keywords: Systemic Bankruptcy; Financial Crises; Global Games (search for similar items in EconPapers)
JEL-codes: D82 E44 G21 (search for similar items in EconPapers)
Pages: 47 pages
Date: 2007-07
New Economics Papers: this item is included in nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
https://www.econ.queensu.ca/sites/econ.queensu.ca/files/qed_wp_1149.pdf First version 2007 (application/pdf)

Related works:
Journal Article: Investment complementarities, coordination failure, and systemic bankruptcy (2013)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:qed:wpaper:1149

Access Statistics for this paper

More papers in Working Paper from Economics Department, Queen's University Contact information at EDIRC.
Bibliographic data for series maintained by Mark Babcock ().