Why not private bailouts?

Abstract

During financial crises, comparing with numerous governmental bailouts, private bailouts from the falling's stakeholders are extremely rare. We provide a network game model to explain this phenomenon. We model the risk appetites of companies in a cross-holding financial network through a failure-threshold game. The game possesses multiple equilibria. In each equilibrium, companies have incentive to exhaust the implicit guarantee from their shareholders. As a result, there is little room for bailouts when a surprise shock hits the network and the system becomes extremely fragile. We also study the cross-holding's non-monotonic effects on the intensity of the moral-hazard problem.