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Please use this identifier to cite or link to this item:
http://hdl.handle.net/2451/30271
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| Title: | Bailout Uncertainty in a Microfounded General
EquilibriumModeloftheFinancial System |
| Authors: | Izhakian, Yehuda
Cukierman, Alex |
| Keywords: | risk
uncertainty
lehman’s default
leverage
financial intermediaries
bailouts
duration mismatches |
| Issue Date: | 16-Sep-2011 |
| Abstract: | This paper develops a micro-founded general equilibrium model of the
financial system composed of ultimate borrowers, ultimate lenders and
financial intermediaries. The model is used to investigate the impact of
uncertainty about the likelihood of governmental bailouts on leverage,
interest rates, the volume of defaults and the real economy. The
distinction between risk and uncertainty is implemented by applying the
Gilboa-Schmeidler (1989) maxmin with multiple priors framework to
lenders’ beliefs about the probability of bailout. Events like
Lehman’s collapse are conceived of as ”black swan”
events that led lenders to put a positive mass on bailout probabilities
that were previously assigned zero mass. Results of the analysis
include: (i) An unanticipated increase in bailout uncertainty raises
interest rates, the volume of defaults in both the real and financial
sectors and may lead to a total drying up of credit markets. (ii) Lower
exante bailout uncertainty is conducive to higher leverage - which
raises moral hazard and makes the economy more vulnerable to expost
increases in bailout uncertainty. (iii) Bailout uncertainty raises the
likelihood of bubbles, the amplitude of booms and busts as well as the
banking and the credit spreads. (iv) Bailout uncertainty is associated
with higher returns’ variability in diversified portfolios and
systemic risks, (v) Expansionary monetary policy reinforces those
effects by inducing higher aggregate leverage levels. |
| URI: | http://hdl.handle.net/2451/30271 |
| Appears in Collections: | Economics Working Papers
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