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http://ssrn.com/abstract=1315462
 
 

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Self-Fulfilling Credit Market Freezes


Lucian A. Bebchuk


Harvard Law School; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR) and European Corporate Governance Institute (ECGI)

Itay Goldstein


University of Pennsylvania - The Wharton School - Finance Department

December 1, 2009

Review of Financial Studies, Vol. 24, No. 11, pp. 3519-3555, 2011
Harvard Law and Economics Discussion Paper No. 623

Abstract:     
This paper develops a model of a self-fulfilling credit market freeze and uses it to study alternative governmental responses to such a crisis. We study an economy in which operating firms are interdependent, with their success depending on the ability of other operating firms to obtain financing. In such an economy, an inefficient credit market freeze may arise in which banks abstain from lending to operating firms with good projects because of their self-fulfilling expectations that other banks will not be making such loans. Our model enables us to study the effectiveness of alternative measures for getting an economy out of an inefficient credit market freeze. In particular, we study the effectiveness of interest rate cuts, infusion of capital into banks, direct lending to operating firms by the government, and the provision of government capital or guarantees to finance or encourage privately managed lending. Our analysis provides a framework for analyzing and evaluating the standard and nonstandard instruments used by authorities during the financial crisis of 2008-2009. Our analysis also provides testable implications for how firms, banks, and economies can be expected to be affected by shocks to the banking system.

Number of Pages in PDF File: 50

Keywords: Credit freeze, self-fulfilling crisis, run on the economy, global games, coordination failure, capital injection, government policy, lender of last resort

JEL Classification: C72, D21, E44, G01, G20

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Date posted: December 13, 2008 ; Last revised: December 7, 2011

Suggested Citation

Bebchuk, Lucian A. and Goldstein, Itay, Self-Fulfilling Credit Market Freezes (December 1, 2009). Review of Financial Studies, Vol. 24, No. 11, pp. 3519-3555, 2011; Harvard Law and Economics Discussion Paper No. 623. Available at SSRN: http://ssrn.com/abstract=1315462

Contact Information

Lucian A. Bebchuk (Contact Author)
Harvard Law School ( email )
Cambridge, MA 02138
United States
617-495-3138 (Phone)
617-812-0554 (Fax)
HOME PAGE: http://www.law.harvard.edu/faculty/bebchuk/
National Bureau of Economic Research (NBER) ( email )
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Centre for Economic Policy Research (CEPR) and European Corporate Governance Institute (ECGI)
Itay Goldstein
University of Pennsylvania - The Wharton School - Finance Department ( email )
The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States
215-746-0499 (Phone)

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