AMBIGUITY, EFFICIENCY ANDBANK BAILOUTS

The paper examines the effects of ambiguity in regulation on the equilibriumallocation. Under ambiguous bailout policy, agents’ suffer from a lack of informationwith regards to the insolvency resolution method, which would bechosen by the regulator if a financial institution fails. In this case, beliefs ofbankers regarding whether an insolvent bank is liquidated, may differ fromthose of depositors. The beliefs may be asymmetric even if bankers and depositorspossess absolutely symmetric information about the policy of the regulator.It is shown that such asymmetry in beliefs can generate an allocativeinefficiency of the bank based economy.....