In multi-armed bandit problems, agents must repeatedly choose among uncertain alternatives whose true values they can learn about only through experimentation. Information acquired from experimentation is valuable because it tells the agent whether to select a particular option again in the future. Economically significant applications include brand choice, natural resource exploration, research and development and, as special cases, job and price search.
The increasing integration of the European banking industry offers the prospect of important gains in terms of efficiency and diversification, but it also creates potential risks. One such risk is associated with the possibility that a shock to a cross%border banks capital will result in a reduction in lending to firms and consumers in an economic environment that is uncorrelated with the origins of that shock. Given the size and penetration of a number of west European and U.S. banks in central and eastern Europe, their financial distress associated with the meltdown of subprime mortgages and securitized products in 2007 and 2008 and the run on banks by short term creditors, counterparties, and borrowers concerned about the liquidity and solvency of the banking sector, may have led to such a realization. The goal of this paper is to put this hypothesis to the test.
We investigate one key mechanism through which foreign financial distress may have been transmitted to local economic conditions, namely the supply of credit to small and medium enterprises. SMEs dominate the corporate landscape in central and eastern Europe, comprising up to 99% of all firms. Moreover, because of their opacity SMEs may be particularly vulnerable to contractions in the supply of credit. With this high dependency on the SME sector and with immature capital markets, banks are by far the main provider of funds for capital investment and expansion. An important feature of the central and eastern European banking market is its ownership structure. In particular, foreign ownership in the banking sector has grown so dramatically in the recent decade, that by 2008 foreign banks controlled around 80% of the assets in the the regions banking industry. The serious financial distress of pan European banks like Erste, KBC, and Societe Generale since 2007 stemming from economic circumstances unrelated to their operation in central and eastern Europe provides a natural experiment to study the channels through which the effects of the financial crisis that started in the U.S. spread through out the global economy.
This paper defines a notion of an equilibrium and a pseudo-equilibrium for infinite horizon economies with incomplete asset markets. This definition generalizes the usual ones for finite horizon economies with incomplete markets and for infinite horizon economies with complete markets. We establish the existence of a pseudo-equilibrium when assets are short-lived and denominated in general commodity bundles; we obtain a true equilibrium when assets are denominated solely in a single numeraire commodity, or in units of account. It seems to us that the notion of an equilibrium we define is a natural and compelling one; as evidence, we show that our notion actually coincides with several other apparently quite distinct notions of an equilibrium.
The crucial issue that divides the infinite horizon setting from the finite horizon setting is the nature of debt constraints. In the finite horizon setting the constraint that there be no debt following the terminal date, together with the budget constraint, imply limits on debt at earlier dates. In the infinite horizon setting these terminal debt constraints and the implied debt constraints at earlier dates are absent If no additional debt constraints were imposed, then an equilibrium could not possibly exist: all traders would attempt to finance unbounded levels ot consumption by unbounded levels of borrowing. When markets are complete, such Ponzi schemes may be ruled out by the simple requirement that debt at each date/event never exceeds the current value of future endowments; this is frequently called a solvency requirement.
