Capital controls as a bargaining device: The case of Iceland

Abstract

AbstractIceland imposed strict capital controls when its banks failed in October 2008. Legacy problems and a large stock of carry‐trade funds locked in by the controls hindered lifting them, but they also helped in resolving the banks. We formulate and calibrate a bargaining model describing the strategic interaction between Iceland and international investors. Outcomes indicate a judicious bargaining approach by Icelandic authorities which was ultimately successful and led to resolution by settlement. The results are robust to reasonable variations in parameter values and are consistent with outcomes in investment arbitration trials and anecdotal evidence from Icelandic case law.