inefficient credit booms this paper studies the welfare properties of competitive equilibria in an economy with financial frictions hit by aggregate shocks in particular it shows that competitive financial contracts can result in excessive borrowing ex ante and excessive volatility ex post even though from a first best perspective the equilibrium always displays under borrowing from a second best point of view excessive borrowing can arise the inefficiency is due to the combination of limited commitment in financial contracts and the fact that asset prices are determined in a spot market this generates a pecuniary externality that is not internalized in private contracts the model provides a framework to evaluate preventive policies which can be used during a credit boom to reduce the expected costs of a financial crisis copyright 2008 wiley blackwell

semicollusion in the norwegian cement market abstract a model of semicollusion where firms collude on prices and compete on capacities is tailor made to the characteristics of the norwegian cement market and tested on this particular market for the period 1927 1982 the results indicate that the rapid increase in capacity and thereby in exports in the period 1956 1967 the late phase of the price cartel best can be explained by the market sharing agreement each firm overinvested in capacity to receive a large quota in the domestic market

monetary union price level convergence and inflation how close is europe to the usa abstract the pattern of price dispersion across european and us cities from 1990 to 2004 is documented there is a striking decline in dispersion for traded goods prices in europe most of which took place prior to the launch of the euro dispersion in the euro area is now quite close to that of the usa this evidence provides useful facts for future work assessing the importance of various developments in europe harmonization of tax rates convergence of incomes and labor costs liberalization of trade and factor markets and increased coherence of monetary policy

how debt markets have malfunctioned in the crisis the financial crisis that began in 2007 is especially a crisis in debt markets a full understanding of what happened in the financial crisis requires investigation into the plumbing of debt markets during a financial crisis when funds often cannot be raised easily or quickly the fundamental values for certain assets can become separated for a time from market prices with consequences that can echo into the real economy this article will explain in concrete ways how debt markets can malfunction with deleterious consequences for the real economy after a quick overview of debt markets i discuss three areas that are crucial in all debt markets decisions risk capital and risk aversion repo financing and haircuts and counterparty risk in each of these areas feedback effects can arise so that less liquidity and a higher cost for finance can reinforce each other in a contagious spiral i will document the remarkable rise in the premium that investors placed on liquidity during the crisis next i will show how these issues caused debt markets to break down indeed fundamental values and market values seemed to diverge across several markets and products that were far removed from the toxic subprime mortgage assets at the root of the crisis finally i will discuss briefly four steps that the federal reserve took to ease the crisis and how each was geared to a specific systemic fault that arose during the crisis

price setting supergames with capacity constraints this paper examines the role of industry capacity in enforcing collusion in the context of repeated games for a fixed capacity per firm it is shown that changes in the number of firms have a non monotone effect on the best enforceable cartel price this is due to the fact that while an additional firm lowers the share that each of the other firms enjoys at the collusive price it also increases the losses to each firm should the cartel fail

menu costs and markov inflation a theoretical revision with new evidence abstract we revisit a foundational theoretical paper in the menu cost literature sheshinski and weiss 1983 optimum pricing policy under stochastic inflation review of economic studies 50 3 513 529 one of the few to treat stochastic inflation with persistent deviations from trend in contrast to the original finding we show that optimal pricing in this environment entails using different s s bands in high inflation and low inflation states of the world the low inflation band is strictly contained within the high inflation band this revised solution has very different implications from the original one firms are generally risk loving not risk averse with respect to inflation an increase in the variance of inflation increases price dispersion when inflation is high and decreases price dispersion when inflation is low on an aggregate level this optimal pricing would lead to bunching of prices and non neutrality of money in the setting of caplin and spulber 1987 menu costs and the neutrality of money quarterly journal of economics 102 4 703 725 to test the main finding we construct an establishment level dataset from the months surrounding mexico s tequila crisis in 1995 in the high inflation state price increases are larger and establishments allow their prices to vary more widely around their respective long run mean relative prices cross establishment price dispersion is lower but this result seems due to decreased establishment heterogeneity rather than narrower s s bands overall the evidence suggests that establishments employ wider s s bands in the high inflation state

capital accumulation games of infinite duration abstract consider a market in which firms accumulate capital according to the nerlove arrow capital accumulation equation each player chooses a path of investment and thus an induced path of capital to maximize his total discounted profits which depend on his own capital and the capital stocks of his rivals existence is proved for such a nonzero sum infinite horizon differential game and conditions under which the game converges to a particular stationary point regardless of the initial conditions are shown thus the game possesses the property of conditional global asymptotic stability

self fulfilling fire sales fragility of collateralised short term debt markets this paper shows that collateralised short term debt although privately optimal for reducing borrowers moral hazard can cause fragility multiple equilibria when the collateral market is illiquid a new form of coordination failure between borrowers ex ante margin and risk taking decisions engenders a systemic run in the collateralised debt market large changes in credit rationing margins repo spreads etc the model also captures the large small crosssectional differences between safe and risky collateral in bad good times finally i show that asset price guarantees could improve welfare and promote stability but repealing repo contracts automatic stay exemption might do the opposite

rollover risk as market discipline a two sided inefficiency abstract why does the market discipline that financial intermediaries face seem too weak during booms and too strong during crises this paper shows in a general equilibrium setting that rollover risk as a disciplining device is effective only if all intermediaries face purely idiosyncratic risk however if assets are correlated a two sided inefficiency arises good aggregate states have intermediaries taking excessive risks while bad aggregate states suffer from costly fire sales the driving force behind this inefficiency is an amplifying feedback loop between asset values and market discipline in equilibrium financial intermediaries inefficiently amplify both positive and negative aggregate shocks

disaggregate evidence on the persistence of consumer price inflation this paper uses disaggregate inflation data spanning all of consumption to examine i the persistence of disaggregate inflation relative to aggregate inflation ii the distribution of persistence across consumption sectors and iii whether persistence has changed assuming mean inflation to be unchanged disaggregate persistence inflation is consistently below aggregate persistence taking into account an early 1990s shift in mean inflation identified by break tests yields much lower estimates of both aggregate and disaggregate persistence for 1984 2002 but with the mean break average disaggregate persistence is actually as great as aggregate inflation persistence a factor model provides a natural framework for interpreting the relationship between aggregate and disaggregate persistence copyright 2006 john wiley sons ltd

collective moral hazard maturity mismatch and systemic bailouts the paper elicits a mechanism by which private leverage choices exhibit strategic complementarities through the reaction of monetary policy when everyone engages in maturity transformation authorities haver little choice but facilitating refinancing in turn refusing to adopt a risky balance sheet lowers the return on equity the key ingredient is that monetary policy is non targeted the ex post benefits from a monetary bailout accrue in proportion to the number amount of leverage while the distortion costs are to a large extent fixed this insight has important consequences first banks choose to correlate their risk exposures second private borrowers may deliberately choose to increase their interest rate sensitivity following bad news about future needs for liquidity third optimal monetary policy is time inconsistent fourth macro prudential supervision is called for we characterize the optimal regulation which takes the form of a minimum liquidity requirement coupled with monitoring of the quality of liquid assets we establish the robustness of our insights when the set of

accounting for persistence and volatility of good level real exchange rates the role of sticky information abstract volatile and persistent real exchange rates are observed not only in aggregate series but also in micro price data at the retail level kehoe and midrigan 2007 recently showed that under a standard assumption on nominal price stickiness empirical frequencies of micro price adjustment cannot replicate the time series properties of the law of one price lop deviations we extend their sticky price model by combining good specific price adjustment with information stickiness in the sense of mankiw and reis 2002 our framework allows for multiple cities within a country using a panel of u s canadian city pairs we estimate a dynamic price adjustment process for 165 individual goods under a reasonable assumption on the money growth process we show that the model matches the persistence of the lop deviation for the median good and accounts for the majority of its volatility when information updates occur every 12 months

estimates of the sticky information phillips curve for the united states mankiw and reis 2002 have proposed a sticky information based phillips curve sipc to address some of the concerns with the sticky price based new keynesian phillips curve in this paper we present a methodology to empirically implement the sipc and estimate its key structural parameter the degree of information stickiness for the united states using this methodology we estimate average durations of information stickiness that range from three quarters on the low side to over seven quarters on the high side

nominal price rigidity money supply endogeneity and business cycles abstract this paper investigates the ability of nominal price rigidity to explain the co movement of inflation with the cyclical component of output observed in the post war u s data a dynamic general equilibrium model is constructed with the introduction of monopolistic competition and nominal price rigidity in a standard real business cycle model allowing for an endogenous money supply rule it is then demonstrated that sticky price models can explain the observed associations between movements in inflation and output much better than flexible price models this result depends little on whether money supply is assumed to be endogenous or not

crisis and competition in expert organizational decision making credit rating agencies and their response to turbulence in emerging economies firms often delegate elements of strategic decisions to outside experts who promise objective assessments which are especially valuable in unstable environments however experts themselves may be prone to skewed decision making as the stability of their own industry environment changes and as their positioning within the industry shifts we examine this possibility in the context of expert credit rating agencies agencies and their risk ratings of emerging market sovereign borrowers ratings published from 1987 to 1998 a period that includes both industry stability 1987 1996 and industry turbulence set off by financial crises in several emerging market countries 1997 1998 after controlling for macroeconomic and related objective risk factors linked to the sovereigns themselves we find several points 1 agency ratings during crisis induced industry turbulence are negatively skewed indicating undue pessimism among these experts in line with decision making perspectives predicting negative reaction by experts in an effort to retain legitimacy with salient stakeholders in this case investors and public regulators 2 this negative shift is greater for incumbent firms and regionally focused firms possibly because of the loss of previous informational advantages and 3 this negative shift during crisis induced turbulence is greater as industry rivalry among these experts increases in particular market segments possibly indicating the development of competitive bandwagons among experts together our results suggest that objective assessments by expert organizations are vulnerable to substantial distortion from the confluent effects of industry instability and expert positioning within the industry particularly positioning affecting rivalry among experts ironically experts may be most likely to mislead clients in unstable industry environments when experts command greater attention and should show greater fidelity to disinterested objectivity

the evolution of a financial crisis collapse of the asset backed commercial paper market this paper documents runs on asset backed commercial paper abcp programs in 2007 we find that one third of programs experienced a run within weeks of the onset of the abcp crisis and that runs as well as yields and maturities for new issues were related to program level and macro financial risks these findings are consistent with the asymmetric information framework used to explain banking panics have implications for commercial paper investors degree of risk intolerance and inform empirical predictions of recent papers on dynamic coordination failures

optimal cartel trigger price strategies abstract a dynamical model of industry equilibrium is described in which a cartel deters deviations from collusive output levels by threatening to produce at cournot quantities for a period of fixed duration whenever the market price falls below some trigger price in this model firms can observe only their own production level and a common market price the market demand curve is assumed to have a stochastic component so that an unexpectedly low price may signal either deviations from collusive output levels or a downward demand shock

pass through in retail and wholesale this paper studies how prices comove across products firms and locations to gauge the relative importance of retailer versus manufacturer level shocks in determining prices i make use of a large panel data set on prices for a cross section of retailers in the u s i analyze prices at the barcode or universal product code upc level for individual stores i find that only 16 of the variation in prices is common across stores selling an identical product 65 of the price variation is common to stores within a particular retail chain but not across retail chains while 17 is completely idiosyncratic to the store and product product categories with frequent temporary sales exhibit a disproportionate amount of completely idiosyncratic price variation my results suggest that most of the observed price variation arises from retail level rather than manufacturer level demand and supply shocks however the behavior of prices is difficult to relate to observed variation in costs and demand at the retail level this suggests that retail prices may vary largely as a consequence of dynamic pricing strategies on the part of retailers or manufacturers rather than static demand and supply shocks this abstract was borrowed from another version of this item

a prism into the ppp puzzles the micro foundations of big mac real exchange rates we match big mac prices with prices of its ingredients as a unique prism to study real exchange rates rers this approach has several advantages first the levels of the big mac rer can be measured meaningfully second as the exact composition of a big mac is known the contributions of its tradable and non tradable components can be estimated relatively precisely third the dynamics of the rer can be studied in a setting free of several biases inherent in cpi based rers finally a large cross country dimension allows us to overturn the engel result on what drives rers in most economies the exchange rate is the single most important relative price one that potentially feeds back into a large range of transactions obstfeld and rogoff 2000

collateral and competitive equilibria with moral hazard and private information the authors examine equilibrium credit contracts and allocations under different competitivity specifications and explain the economic roles of collateral under these specifications both moral hazard and adverse selection are considered the principal message is that how a competitive equilibrium is conceptualized significantly affects the characterization of equilibrium credit contracts specifically some well known results in the rationing literature are shown to rest delicately on the adopted equilibrium concept two somewhat surprising results emerge first high quality borrowers with unlimited collateral may be priced out of the market despite the bank having idle deposits second high quality borrowers may put up more collateral this paper explores the allocational consequences of alternative credit market competitivity specifications and explains the different economic roles of collateral under these specifications we model banks that lend to borrowers financing projects with payoffs depending on a priori unknown borrower attributes and ex post unobservable borrower actions borrowers are assumed to have unconstrained access to collateral our analysis is based on two concepts of competitive equilibrium under both banks compete in the sense that they earn zero expected profits however under the first concept of equilibrium ti as in jaffee and russell 11 all rents accrue to borrowers whereas under the second concept t2 all rents accrue to depositors as in stiglitz and weiss 17 our research makes two main points first we demonstrate that the manner in which a competitive equilibrium is conceptualized importantly influences the characterization of equilibrium credit allocations specifically one of the findings is that the rationing equilibria of stiglitz and weiss 17 and others should be viewed as rather delicate things in that they are very sensitive to the competitivity specification used for instance

competition innovation and the use of innovations i examine the effect of competition on the production and use of innovations using evidence from a natural experiment of policy reform the introduction of cartel legislation in the uk in the late 1950s i compare manufacturing industries which had been collusive and were therefore affected by the policy with those that had been competitive and were not affected the intensification of competition following the abolition of cartels caused a short run decrease in innovations produced but had no significant effect in the long run in contrast innovations used increased both in the short run and in the long run

five facts about prices a reevaluation of menu cost models are price decreases 3 the frequency of price increases covaries strongly with inflation whereas the frequency of price decreases and the size of price increases and price decreases do not 4 the frequency of price change is highly seasonal it is highest in the first quarter and then declines 5 we find no evidence of upwardsloping hazard functions of price changes for individual products we show that the first second and third facts are consistent with a benchmark menu cost model whereas the fourth and fifth facts are not

european product market integration after the euro using a detailed data set of prices of consumer goods in european cities from 1990 to spring 2003 we investigate the question of whether the introduction of the euro in january 1999 increased integration of consumer markets as reflected by consumer prices in fact we find no tendency for prices to converge after january 1999 this finding holds even when we control for a number of factors that might affect price dispersion on the other hand we find that there has been a significant reduction in price dispersion throughout the decade of the 1990s suggesting that efforts to reduce economic barriers initiated early in the decade may have in fact had the effect of significantly increasing the integration of consumer markets charles engel and john h rogers

learning from a piece of pie we investigate the empirical content of the nash solution to two player bargaining games the bargaining environment is described by a set of variables that may affect agents preferences over the agreement sharing the status quo outcome or both the outcomes i e whether an agreement is reached and if so the individual shares and the environment including the size of the pie are known but neither are the agents utilities nor their threat points we consider both a deterministic version of the model in which the econometrician observes the shares as deterministic functions of the variables under consideration and a stochastic one in which because of latent disturbances only the joint distribution of incomes and outcomes is recorded we show that in the most general framework any outcome can be rationalized as a nash solution however even mild exclusion restrictions generate strong implications that can be used to test the nash bargaining assumption stronger conditions further allow to recover the underlying structure of the bargaining and in particular the cardinal representation of individual preferences in the absence of uncertainty an implication of this finding is that empirical works entailing nash bargaining could and should use much more general and robust versions than they usually do copyright 2012 oxford university press

capital investments and price agreements in semicollusive markets we consider a semicollusive market where firms compete in a long run variable such as investment in capital or capacity and collude with respect to a short run variable such as price or market shares our concern is with the potential destabilizing effect of the long run competition on the short run collusion we show that under a certain refinement of the equilibrium the set of equilibria is reduced to include just the one in which the collusive agreement is stable we then lend some support to the phenomenon of an inverse association between advertising and competition by investigating the conditions under which overcapitalization occurs in the above equilibrium

monetary policy as financial stability regulation this paper develops a model that speaks to the goals and methods of financialstability policies there are three main points first from a normative perspective the model defines the fundamental market failure to be addressed namely that unregulated private money creation can lead to an externality in which intermediaries issue too much short term debt and leave the system excessively vulnerable to costly financial crises second it shows how in a simple economy where commercial banks are the only lenders conventional monetary policy tools such as open market operations can be used to regulate this externality while in more advanced economies it may be helpful to supplement monetary policy with other measures third from a positive perspective the model provides an account of how monetary policy can influence bank lending and real activity even in a world where prices adjust frictionlessly and there are other transactions media besides bank created money that are outside the control of the central bank

collateral and rationing sorting equilibria in monopolistic and competitive credit markets the authors examine how market structure affects credit allocation under universal risk neutrality and asymmetric information about borrowers they consider both monopolistic and perf ectly competitive banks and examine the role of collateral in each ca se when a bank is a monopolist on the loan side they find collatera l is never used and asymmetric information results in reduced bank le nding under perfect competition collateral has a useful sorting rol e moreover rationing is possible even with collateral availability and perfectly elastic deposit supply in this setting the authors sh ow co signers are valuable social welfare properties of the monopoly and competitive equilibria are also compared copyright 1987 by economics department of the university of pennsylvania and the osaka university institute of social and economic research association

dynamic debt runs we develop a dynamic model of debt runs on a rm which invests in an illiquid asset by rolling over staggered short term debt contracts i e dierent contracts mature at dierent times we derive a unique threshold equilibrium in which creditors coordinate their asynchronous rollover decisions based on the rm s publicly observable and time varying fundamental the coordination problem ampli es the creditors concerns about the rm s future rollover risk created by its time varying fundamental and causes each maturing creditor to run ahead of others even when the current fundamental is substantially higher than its liability our model provides a set of implications on the roles played by volatility illiquidity and debt maturity in driving debt runs as well as on rms capital adequacy standards and credit risk

intermediary asset pricing abstract we model the dynamics of risk premia during crises in asset markets where the marginal investor is a financial intermediary intermediaries face an equity capital constraint risk premia r

outside and inside liquidity we propose an origination and contingent distribution model of banking in which liquidity demand by short term investors can be met with cash reserves inside liquidity or sales of assets outside liquidity to long term investors outside liquidity is a more e cient source but asymmetric information about asset quality can introduce a friction in the form of excessively early asset trading in anticipation of a liquidity shock excessively high cash reserves and too little origination of assets by banks the model captures elements of the current flnancial crisis and yields policy prescriptions on public liquidity provision to overcome liquidity crises

persistent real exchange rates abstract three well known facts that characterize exchange rate data are a the high correlation between bilateral nominal and real exchange rates b the high degree of persistence in real exchange rate movements and c the high volatility of real exchange rates this paper attempts a joint albeit partial rationalization of these facts in an environment with no staggered contracts and where prices are preset for only one quarter there are two key innovations in the paper first we augment a standard two country open economy model with learning by doing in production at the firm level this induces monopolistically competitive firms to endogeneize the productivity effect of their price setting behavior specifically firms endogenously choose not to adjust prices by the full proportion of a positive monetary shock in order to take advantage of the productivity benefits of higher production second we introduce habits in leisure this makes the labor supply decision dynamic and adds an additional source of propagation we show that the calibrated model can quantitatively reproduce significant fractions of the aforementioned facts moreover as in the data the model also produces a positive correlation between the terms of trade and the nominal exchange rate

repo runs evidence from the tri party repo market the repo market has been viewed as a potential source of financial instability since the 2007 to 2009 financial crisis based in part on findings that margins increased sharply in a segment of this market this paper provides evidence suggesting that there was no system wide run on repo using confidential data on tri party repo a major segment of this market we show that the level of margins and the amount of funding were surprisingly stable for most borrowers during the crisis however we also document a sharp decline in the tri party repo funding of lehman in september 2008

fear of fire sales illiquidity seeking and credit freezes is there any need to clean up a banking system in the midst of a crisis for instance by closing some weak banks and forcing others to sell bad assets or can one wait till the crisis is over we argue that an overhang of impaired banks that may be forced to sell assets in the future can increase the private returns to holding illiquid assets sufficiently that weak banks have no interest in selling them anticipating a potential future fire sale cash rich buyers have high expected returns to holding cash which also reduces their incentive to lock up money in term loans the potential for a worse fire sale than necessary as well as the associated decline in credit origination could make the crisis worse which is one reason it may make sense to clean up the system even in the midst of the crisis we discuss alternative ways of cleaning up the system and the associated costs and benefits

collusion in a price quantity oligopoly abstract in the context of an infinitely repeated oligopoly game we study collusion among firms that simultaneously choose prices and quantities we compare a price cartel with a price quota cartel and analyze when and why firms prefer the latter to the former output quota may be required to solve coordination and incentive problems when market demand is sufficiently elastic if market demand is sufficiently inelastic then the cartel faces a trade off between increasing prices and the amount of costly overproduction we find that a price cartel prices consistently below the monopoly price to mitigate excessive production in this case a quota arrangement allows firms to avoid overproduction and to sustain the monopoly price from a policy perspective our findings suggest that an overall price increase in conjunction with more stable prices and market shares is indicative of collusion in industries where production precedes sales and outputs are imperfectly observable

optimal long term financial contracting we develop an agency model of financial contracting we derive long term debt a line of credit and equity as optimal securities capturing the debt coupon and maturity the interest rate and limits on the credit line inside versus outside equity dividend policy and capital structure dynamics the optimal debt equity ratio is history dependent but debt and credit line terms are independent of the amount financed and in some cases the severity of the agency problem in our model the agent can divert cash flows we also consider settings in which the agent undertakes hidden effort or can control cash flow risk

turnpike properties of capital accumulation games abstract a differential game is considered in which players accumulate capital their payoff functions depend upon the capital stocks of both players and their cost functions are convex previous existence and stability results are relied upon to show that the game under an additional assumption possesses the following properties a every equilibrium of the infinite horizon game converges to the unique stationary equilibrium b for a time horizon long enough the finite horizon equilibrium stays in the neighborhood of the infinite horizon equilibrium except for some final time c for a time horizon long enough the finite horizon equilibrium stays in the neighborhood of the stationary equilibrium except for some initial and final time

coordination failures and the lender of last resort was bagehot right after all the classical doctrine of the lender of last resort lolr elaborated by bagehot 1873 asserts that the central bank should lend to illiquid but solvent banks under certain conditions several authors have argued that this view is now obsolete in modern interbank markets a solvent bank cannot be illiquid this paper provides a possible theoretical foundation for rescuing bagehot s view our theory does not rely on the multiplicity of equilibria that arises in classical models of bank runs we built a model of banks liquidity crises that possesses a unique bayesian equilibrium in this equilibrium there is a positive probability that a solvent bank cannot find liquidity assistance in the market we derive policy implications about banking regulation solvency and liquidity ratios and interventions of the lender of last resort furthermore we find that public bailout and private bail in involvement are complementary in implementing the incentive efficient solution and that bagehot s lender of last resort facility must work together with institutions providing prompt corrective action and orderly failure resolution finally we derive similar implications for an international lender of last resort ilolr jel g21 g28

integrating sticky prices and sticky information abstract understanding the relationship between nominal and real variables most notably inflation and cyclical output is one of the fundamental questions of economics toward this understanding we develop a model that integrates sticky prices and sticky information a dual stickiness model we find that both rigidities are present in u s data we also show that the dual stickiness model s closest competitor is the hybrid new keynesian model for both models current inflation depends in part on last period s inflation the former model achieves this dependence endogenously through the interaction of the two rigidities rather than through backward looking behavior u s data support the dual stickiness model over the hybrid model because lagged expectations terms appear in the former s inflation euler equation finally we show that it is quantitatively important to distinguish between the two by simulating a dynamic equilibrium model under each of the two inflation equations

on the use of collateral this paper surveys existing explanations for the pervasive use of collateral in credit markets and relates them to the empirical evidence on the subject collateral may be used as a screening or an incentive device in markets characterized by various forms of asymmetric and biased information the evidence is incompatible with the use of collateral as a signal of projects quality while broadly consistent with explanations based on its incentive properties and asymmetric evaluation of projects copyright 2000 by blackwell publishers ltd

repo market effects of the term securities lending facility the term securities lending facility tslf was recently introduced by the federal reserve to promote liquidity in the financing markets for treasury and other collateral we evaluate one aspect of the program the extent to which it has narrowed repo spreads between treasury collateral and lower quality collateral we find that tslf operations have precipitated a significant narrowing of repo spreads more refined tests indicate the market conditions and types of operations associated with the program s effectiveness various additional tests including a split sample test suggest that our findings are robust

liquidity shortages and banking crises we show in this article that bank failures can be contagious unlike earlier work where contagion stems from depositor panics or contractual links between banks we argue that bank failures can shrink the common pool of liquidity creating or exacerbating aggregate liquidity shortages this could lead to a contagion of failures and a total meltdown of the system given the costs of a meltdown there is a possible role for government intervention unfortunately liquidity and solvency problems interact and can cause each other making it hard to determine the cause of a crisis we propose a robust sequence of intervention banks are often found at the center of systemic financial crises the causes of these crises have long been debated do they stem from depositor panics or do they arise because bank balance sheets are exposed to common factors if it is the latter then is there any sense in which bank failures can be contagious can anything be done to prevent these crises or stop them from propagating once they begin our purpose in this paper is to reexamine whether bank failures can start and propagate systemic crises even if we assume that depositors do not panic that is even if depositors actions are coordinated and they do not run simply because they fear others will run our focus is not because we think that panics are empirically unimportant the jury is still out on that instead we show that contagion can stem from an underlying real general equilibrium problem rather than just from lack of coordination among depositors from a policy perspective attempts to reassure investors through confidence building measures will not work if panic and lack of coordination are not the reasons for a crisis we begin in this paper with a model of a bank that we developed in diamond and rajan 2001 assets in this model are illiquid they cannot be borrowed against or sold for the full value of resources they will generate in their best use because the human capital necessary to generate that full value cannot

rollover risk and market freezes the debt capacity of an asset is the maximum amount that can be borrowed using the asset as collateral we model a sudden collapse in the debt capacity of good collateral we assume short term debt that must be frequently rolled over a small transaction cost of selling collateral in the event of default and a small probability of meeting a buy to hold investor we then show that a small change in the asset s fundamental value can be associated with a catastrophic drop in the debt capacity the kind of market freeze observed during the crisis of 2007 to 2008 one of the many striking features of the crisis of 2007 to 2008 was the sudden freeze in the market for the rollover of short term debt from an in stitutional perspective the inability to borrow overnight against high quality but long term assets was a market failure that effectively led to the demise of a substantial part of investment banking in the united states more broadly it led to the collapse in the united states the united kingdom and other countries of banks and other financial institutions that had relied on signifi cant maturity mismatch between assets and liabilities and in particular on the rollover of short term wholesale debt in the asset backed commercial paper abcp and overnight sale and repurchase repo markets in this paper we are interested in developing a model of a sudden collapse in the ability to borrow short term against long lived assets in the absence of obvious problems of asymmetric information or fears about the value of col lateral we refer to this phenomenon as a market freeze more precisely a market freeze occurs when the debt capacity the maximum amount of collat eralized borrowing that can be supported by an asset is a small fraction of the fundamental value the economic value measured by the net present value npv of the stream of future returns an extreme form of a market freeze occurs when the fundamental value is close to the maximum possible value of the asset whereas the debt capacity is close to the minimum possible value of the asset

a dynamic oligopoly with collusion and price wars we provide a collusive framework with heterogeneity among jirms investment entry and exit it is a symmetric information model in which it is hard to sustain collusion when there is an activejim that is likely to exit in the near future numerical analysis is used to compare a collusive to a noncollusive environment only the collusive industry generates price wars also the collusive industry offers both more and higherquality products to consumers albeit often at a higher price the positive effect of collusion on variety and quality more than compensates consumers for the negative effect of collusive prices so that consumer surplus is larger with collusion

the fragility of short term secured funding markets abstract this paper develops an infinite horizon model of financial institutions that borrow short term and invest in long term assets that can be traded in frictionless markets because these financial intermediaries perform maturity transformation they are subject to potential runs we derive distinct liquidity collateral and asset liquidation constraints which determine whether a run can occur as a result of changing market expectations we show that the extent to which borrowers can ward off an individual run depends on whether it has sufficient liquidity collateral and asset liquidation capacity these determinants depend on the borrower s endogenous balance sheet and on exogenous fundamentals systemic runs are possible if shocks to the valuation of collateral held by outside investors are sufficiently strong and uniform and if the system as a whole is exposed to high short term funding risk the theory has policy implications for prudential regulation and lender of last resort interventions

implications of rational inattention abstract a constraint that actions can depend on observations only through a communication channel with finite shannon capacity is shown to be able to play a role very similar to that of a signal extraction problem or an adjustment cost in standard control problems the resulting theory looks enough like familiar dynamic rational expectations theories to suggest that it might be useful and practical while the implications for policy are different enough to be interesting