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Self-Fulfilling Credit-Market Freezes

42 Pages Posted: 17 Mar 2010 Last revised: 7 Dec 2011

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

Multiple version iconThere are 3 versions of this paper

Date Written: December 1, 2009

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, 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 lending. 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 financial institutions, direct lending to operating firms by the government, and infusion of capital into financial firms under lending commitment.

Suggested Citation

Bebchuk, Lucian A. and Goldstein, Itay, Self-Fulfilling Credit-Market Freezes (December 1, 2009). AFA 2011 Denver Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1571484 or http://dx.doi.org/10.2139/ssrn.1571484

Lucian A. Bebchuk

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 (Contact Author)

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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