Abstract
The interaction of worsening fundamentals and strategic complementarities among investors renders identification of self-fulfilling runs challenging. We propose a dynamic model to show how exogenou...
Highlights
The financial crisis of 2007-2008 highlighted the vulnerability of shadow banking and financial markets to runs
We exploit the contractual structure of a particular type of tradable liability issued by U.S life insurers, extendable funding agreement-backed notes (XFABN), to
33 To be a member of an Federal Home Loan Banks, a life insurer needs to have at least 10 percent of its assets linked to real estate and can obtain advances in proportion to its membership capital that are fully collateralized by real estate-linked and other eligible assets
Summary
The financial crisis of 2007-2008 highlighted the vulnerability of shadow banking (e.g., asset-backed commercial paper conduits) and financial markets (e.g., repo) to runs. Note that if other investors with an opportunity to exercise their option in the future choose to convert their XFABN after t, the associated final maturity payments would be scheduled for a date later than t + m, and would not affect the liquidity of the issuer in a significant way.17 The addition of her spinoff to the queue of payment would in turn have a negative effect on the expected future liquidity of the issuer, inducing other investors’ to convert their XFABN between t and t + 1 This realization confirms the original expectation, giving rise to a self-fulfilling run. Corollary 2.3 Regardless of heterogeneity in investors’ information about fundamentals, a run on XFABN could be a self-fulfilling run, if and only if α > 0
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