Appendix I. Pareto Dominant Equilibria
Under the standard Nash equilibrium concept banks are assumed to be unable to communicate. Suppose banks can communicate and form any coalition, and the outcome of their interaction is a “Pareto-dominant” equilibrium26. A symmetric NMH equilibrium is Pareto-dominant if
Under this equilibrium concept, the implications of the CVH model for risk and asset allocation are reversed. The model predicts a decline in risk as competition increases (as in the BDN model), but also a decline in the loan-to-asset ratio. By contrast, the implications of the BDN model under this notion of equilibrium are not different from those obtained under a standard Nash equilibrium when banks’ monopoly rents are not “too large”.