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Coordination risk and the price of debt

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Creditors of a distressed borrower face a coordination problem. Even if the fundamentals are sound, fear of premature foreclosure by others may lead to pre-emptive actions, undermining the project. Recognition of this problem lies behind corporate bankruptcy provisions across the world, and it has been identified as a culprit in international financial crises, but has received scant attention from the literature on debt pricing. Without common knowledge of fundamentals, the incidence of failure is uniquely determined provided that private information is precise enough. This affords a way to price the coordination failure. There are two further conclusions. First, coordination is more difficult to sustain when fundamentals deteriorate. Thus, when fundamentals deteriorate, the onset of crisis can be very swift. Second, transparency in the sense of greater provision of information to the market does not generally mitigate the coordination problem.

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en

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application/pdf

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http://eprints.lse.ac.uk/25046/1/dp373.pdf

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