Resolution of financial crises
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Resolution of financial crises. / Gonzalez-Eiras, Martin; Fanelli, Sebastian.
In: Journal of Economic Dynamics and Control, Vol. 133, 104252, 11.10.2021, p. 1-28.Research output: Contribution to journal › Journal article › Research › peer-review
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TY - JOUR
T1 - Resolution of financial crises
AU - Gonzalez-Eiras, Martin
AU - Fanelli, Sebastian
PY - 2021/10/11
Y1 - 2021/10/11
N2 - A financial crisis creates substantial wealth losses. How these losses are allocated determines the magnitude of the crisis and the path to recovery. We study how institutions and technological factors that shape default and debt restructuring decisions affect the amplification of aggregate shocks. For sufficiently large shocks, agents renegotiate. This limits the losses borne by borrowers, shutting the amplification mechanism via asset prices. The range of shocks that trigger renegotiation is decreasing in repossession costs and increasing in default costs, if the latter are public information. Private information may induce equilibrium default but, by allowing agents with high default costs to extract a larger haircut, facilitates the recovery. The model is consistent with evidence from real estate markets in the U.S. during the Great Recession; and rationalizes recent changes in U.S. Bankruptcy Code in the wake of the COVID-19 crisis.
AB - A financial crisis creates substantial wealth losses. How these losses are allocated determines the magnitude of the crisis and the path to recovery. We study how institutions and technological factors that shape default and debt restructuring decisions affect the amplification of aggregate shocks. For sufficiently large shocks, agents renegotiate. This limits the losses borne by borrowers, shutting the amplification mechanism via asset prices. The range of shocks that trigger renegotiation is decreasing in repossession costs and increasing in default costs, if the latter are public information. Private information may induce equilibrium default but, by allowing agents with high default costs to extract a larger haircut, facilitates the recovery. The model is consistent with evidence from real estate markets in the U.S. during the Great Recession; and rationalizes recent changes in U.S. Bankruptcy Code in the wake of the COVID-19 crisis.
KW - Faculty of Social Sciences
KW - financial crises
KW - balance sheet recessions
KW - default
KW - renegotiation
U2 - 10.1016/j.jedc.2021.104252
DO - 10.1016/j.jedc.2021.104252
M3 - Journal article
VL - 133
SP - 1
EP - 28
JO - Journal of Economic Dynamics and Control
JF - Journal of Economic Dynamics and Control
SN - 0165-1889
M1 - 104252
ER -
ID: 283524595