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October 30, 2014

Canadian Excellence


Jack (Jacques) A. Schnabel

Bankruptcy and the Nash Solution (ABSTRACT)

Dr. Jacques A. Schnabel

published: 2007 | Research publication | Publications

Schnabel, J. (2007). "Bankruptcy and the Nash Solution",†Applied Financial Economics Letters†3 (4),†251-252.

ABSTRACT: This paper reexamines the Nash bargaining solution in the context of the bankruptcy settlement game. It is shown that the usual textbook critique of the Nash bargaining solution is flawed. The putative shortcoming of the Nash bargaining solution, viz. it leads to bizarre bankruptcy settlements, derives not from the solution procedure itself but from an unrealistic assumption regarding the alternatives available to the bankrupt firmís creditors. The latter refers to the likely outcome of formal bankruptcy proceedings, which constitute the second stage of the bankruptcy proceedings. The substitution of a more realistic assumption results in a Nash bargaining solution which accords with both common sense and empirically observed legal outcomes. These conclusions are shown to be valid assuming, on the one hand, that the debt claimants are risk-neutral and, on the other hand, that they both exhibit seriatim risk-averse hyperbolic and logarithmic utility functions.††

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revised Jul 26/07

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