Public and Private Guarantee Funds with Market Fragility

When buyers worry that sellers may not remain in the market long enough to fulfill all contractual obligations, they may be unwilling to purchase and a market failure can result. Bank deposits and pension benefits are examples of contracts for which buyers might lose confidence in sellers, making these markets “fragile.” This paper studies market fragility created by both fundamental (i.e., costs and demand) and strategic uncertainty (i.e., beliefs). We find a rich interaction between these two sources of uncertainty. The paper also considers the role and design of guarantee funds—some public, some private—created to support trade in many potentially fragile markets.