Research and Studies

Home > Research and Studies > Bank of Japan Working Paper Series, Review Series, and Research Laboratory Series > Bank of Japan Working Paper Series 2011 > (Research Paper) A Global Game Analysis of Emergent Liquidity Provision

A Global Game Analysis of Emergent Liquidity Provision and the Role of Creditors' Aggregate Behavior as Signaling

August 2011
Junnosuke Shino*1

Click on Full Text [PDF 223KB]

Abstract

Recent funding problems experienced by European sovereigns and the subsequent policy actions have renewed interest in emergent liquidity provision or the international Lender of Last Resort. This paper constructs an abstract model about emergent liquidity lending by using global game techniques. Compared with the existing models, our model can be characterized by the followings: (1) the authority to provide liquidity (policy maker) is an explicit player in the game rather than an implicit unity appeared in comparative statics, (2) the policy maker cannot distinguish between solvency and insolvency of the liquidity borrower ex ante, (3) liquidity lending rates are endogenously determined, and (4) the policy maker's decision making is set after observing creditors' aggregate behaviors of withdrawing their loans to the borrower. With this setup, it is shown that: (1) creditors' aggregate behavior operates as a signal to the policy maker about borrower's solvency, (2) the policy maker's optimal strategy is to help only illiquid but solvent borrowers, (3) whenever the liquidity lending facility is utilized, optimal lending rates are strictly positive, and (4) the optimal lending rates are "conditionally punitive" in the sense that they take the highest level possible under the restriction that the rates enable solvent but illiquid borrowers to survive.

The author is grateful for valuable comments from Michael Bordo, Colin Campbell, Ippei Fujiwara, Masazumi Hattori, Yuichiro Kamada, Yukisato Ohta, Daijiro Okada, Jean-Charles Rochet, Tomas Sjöström, and seminar participants at 6th Pan Pacific Conference on Game Theory, Tokyo Institute of Technology, February 28, 2011 and Game Theory Workshop, Nagoya University, March 6, 2011.

  •   *1 Financial Markets Department (currently Research and Statistics Department), Bank of Japan.
    E-mail : junnosuke.shino@boj.or.jp

Notice

Papers in the Bank of Japan Working Paper Series are circulated in order to stimulate discussion and comments. Views expressed are those of authors and do not necessarily reflect those of the Bank.
If you have any comment or question on the working paper series, please contact each author.
When making a copy or reproduction of the content for commercial purposes, please contact the Public Relations Department (webmaster@info.boj.or.jp) at the Bank in advance to request permission. When making a copy or reproduction, the source, Bank of Japan Working Paper Series, should explicitly be credited.