Financial Crises as a Phenomenon of Multiple Equilibria and How to Select among Them

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Abstract

When equilibrium is indeterminate (i.e., not unique), applied theory often obtains uniqueness either via ad hoc sunspots or via global games. This paper highlights the relative merits of a third selection mechanism—best-response dynamics (BRD)—in the context of various financial crisis frameworks. For example, in the context of a bank run, selection via BRD is preferred (to ad hoc sunspots) because it provides an explicit coordination narrative and (to global games) because it accounts for the fact that depositors realistically may decide to join or leave a bank's queue upon observing its length.

Real Interest Rates, Bank Borrowing, and Fragility

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Abstract

How do real interest rates affect financial fragility? We study this issue in a model where bank borrowing is subject to rollover risk. A bank's optimal borrowing trades off the benefit from investing additional funds into profitable assets with the cost of greater risk of a run by creditors. Changes in the interest rate affect the price and amount of borrowing, which influence bank fragility in opposite directions. Thus, the marginal impact of changes to the interest rate on bank fragility depends on the level of the interest rate. Finally, we derive testable implications that may guide future empirical work.

Conditional Mandates on Management Earnings Forecasts: The Impact on the Cost of Debt

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Exploiting a unique conditional disclosure mandate on management earnings forecasts (MEFs) in China, we examine the differential effects of voluntary and mandatory MEFs on the cost of debt. We find that firms providing voluntary MEFs have lower cost of debt than do mandatory forecasters and nonforecasters. The results of the channel analyses reveal that voluntary forecasters have greater commitment to voluntary MEFs in future periods than do mandatory forecasters and nonforecasters, and the precision, accuracy, and timeliness of MEFs are higher for voluntary forecasters than for mandatory forecasters. Additional analyses show that the differential effects of voluntary and mandatory MEFs on cost of debt are stronger for voluntary forecasters operating in opaque information environments, issuing high-quality and confirming forecasts, controlled by private shareholders, and operating in highly competitive product markets. Overall, our results indicate that, compared with mandatory MEFs, voluntary MEFs are more informative for credit investors, particularly for firms facing greater information risk and operating uncertainty.