Contagion of a Crisis, Corporate Governance, and Credit Rating

Abstract

My dissertation aims at understanding three critical issues confronting the nancial world: contagion of a crisis, corporate governance, and credit rating. It contains four chapters.1 Through examining the contagion of a crisis, Chapter 1 presents a model in which the contagion of a liquidity crisis between two nonnancial institutions occurs due to the learning within a common creditor pool. After creditors observe what occurs in a rm's rollover game, they conjecture each other's type, or the attitude toward the risk of a rm's investment project. Creditors' inference of others' types then affects their own decisions with regard to the next rm that they lend to. Through the analysis of each rm's incidence of failure – the threshold for a liquidity crisis – I demonstrate that the risk of contagion rises in an important way if originating from a rm that ex-ante faces a small probability of failure. I also offer policy proposals to mitigate the severity of contagion in such liquidity crises. Then, Chapter 2 extends this contagion idea to delve into the effect of enhanced distribution of public information by the central bank on the contagion of a currency crisis between two countries. In the speculators' learning process about each other's aggressiveness in regard to the speculation as the contagion mechanism of a currency crisis, the impact of the contagion can be either negative or positive. Through the analysis of each country's threshold for a currency crisis, I show that the public signal distributed by the central bank promotes the positive effect of the contagion and reduces the negative effect of the contagion on the currency crisis from the other country. I also demonstrate that the effectiveness of the high precision of the public signal depends on the ex-ante expected state of the economic fundamentals of the country. 1 Chapter 3 and Chapter 4 are written jointly with Kyung Suh Park and Sung-Tae Kim, respectively.