Reference no: EM133109557

Question - Assume that there is a newly opened bank. The first business of the bank is a 1-year loan for a start-up company of $2 million (M). To get the money ready for this loan, the bank offers a 20% interest rate to attract people to deposit in the bank.

There are two clients (Client 1 and Client 2) with $1M. They can decide whether to deposit all the money in the bank or not. The bank can proceed to the loan business only if both clients agree to deposit in the bank.

If one or both clients don't deposit at the beginning, both clients keep their balance of $1M. If both clients agree to deposit, the bank can lend the money to the company. Both clients can get their principals and interests (i.e., in total it is $1.2 M) if both clients withdraw after 1 year (i.e. Withdraw after the due date of the loan, a.k.a. due withdrawal). However, if any client requires to get back the money in less than 1 year (i.e. early withdrawal), the bank must cease the loan. But only 80% of the loan amount can be returned. For this 80% of the loan amount, if only one client requires to get back the money in less than 1 year, he/she can get back the full deposit. The remaining amount will be given to the other client. If both clients require to get back the money in less than 1 year, then each client can only get the equal amount from 80% of the loan amount.

(a) Assume that the actions of both clients are unobservable to each other. According to the context, interpret the interaction as a game of two clients (Client 1 and Client 2).

(b) Analyse the pure strategy equilibrium and discuss the implication of the model in reality.