gglp-comment

Endogenous Valuation and FinancialFragility: A CommentDouglas GaleDepartment of EconomicsNew York University269 Mercer StreetNew York, NY 10003USAJanuary 31, 2004Inthiselegantandwellcraftedpaper,Gobert,Gonzalez,LaiandPoitevin(henceforth GGLP) address an important subject, the allocation of liquidityand its impact on the stability of the economy. In an Arrow-Debreu worldwithcompletemarkets, everycommodityisperfectlyliquidandliquiditycanbe taken for granted. By contrast, in a world with incomplete markets, theallocation of liquidity may be far from optimal. GGLP highlight a particu-lar source of market failure, arguing that, when markets are incomplete, themarket value of a firm does not reflect the value of future liquidity servicesit can provide to the market. As a result, the decision whether to continueor terminate a firm may be ine fficient. Furthermore, when markets are in-complete, ine fficient bankruptcy decisions have multiplier e ffects that can beinterpreted as a form of financial fragility.One of the features of the paper that I liked most is that it provides agenuinelygeneral-equilibriumanalysisofliquidityprovision. Thisisessentialbecause the termination decisions of individual firms help determine and arein turn determined by the aggregate supply of liquidity. Another attractivefeature of the paper is the central role played by the valuation of the firm.It is obvious that a firm’s market value is crucial in determining whether itwill fail or ...