Federal Reserve Bank of San Francisco
Working Papers in Applied Economic Theory
Solvency runs, sunspot runs, and international bailouts
This paper introduces a model of international lender of last resort (ILLR) activity under asymmetric information. The ILLR is unable to distinguish between runs due to debtor insolvency and those which are the result of pure sunspots. Nevertheless, the ILLR can elicit the underlying state of nature from informed creditors by offering terms consistent with generating a separating equilibrium. Achieving the separating equilibrium requires that the ILLR lends to the debtor at sufficiently high rates. This adverse electing problem provides an alternative rationale for Bagehot's Principle of last-resort lending at high rates of interest to the moral hazard motivation commonly found in the literature.
Mark M. Spiegel, Solvency runs, sunspot runs, and international bailouts, Working Papers in Applied Economic Theory 2001-05, Federal Reserve Bank of San Francisco, 2000.
Keywords: Financial crises ; Lenders of last resort ; Debt
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