Bankruptcy in Credit Chains

Cyril Monnet and Frédéric Boissay

No 133, Econometric Society 2004 North American Winter Meetings from Econometric Society

Abstract: When firms use bank oans and trade credit,bankruptcy rules can magnify aggregate fluctuations.A priori,a rule where banks are senior is not appropriate to dampen fluctuations.It might force trade creditors into bankruptcy by triggering a ‘domino e ffect ’-when firms go bust because their clients default.Yet,banks are often senior.In this paper,we characterize the conditions under which such a rule limits the likelihood of bankruptcies.We model a credit chain where in equilibrium firms use trade credit and bank loans.Due to the credit chain,bank seniority minimizes the overall risk premium charged by trade creditors and banks.Although bank seniority magni fies the domino e ffect,we find it is optimal whenever there is a relatively high proportion of bad risks

Keywords: bankruptcy; trade credit; credit chains (search for similar items in EconPapers)
JEL-codes: E32 (search for similar items in EconPapers)
Date: 2004-08-11
New Economics Papers: this item is included in nep-dge
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Persistent link: https://EconPapers.repec.org/RePEc:ecm:nawm04:133

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