The Role of Dispersed Information in Pricing Default: Evidence from the Great Recession

FEDS Working Paper No. 2015-079

http://dx.doi.org/10.17016/FEDS.2015.079

58 Pages Posted: 27 Sep 2015 Last revised: 24 Oct 2015

See all articles by Emanuele Brancati

Emanuele Brancati

Sapienza University of Rome; IZA Institute of Labor Economics; Sapienza University of Rome - Faculty of Economics

Marco Macchiavelli

Isenberg School of Management

Date Written: August 13, 2015

Abstract

The recent Global Games literature makes important predictions on how financial crises unfold. We test the empirical relevance of these theories by analyzing how dispersed information affects banks' default risk. We find evidence that precise information acts as a coordination device which reduces creditors' willingness to roll over debt to a bank, thus increasing both its default risk and its vulnerability to changes in expectations. We establish two new results. First, given an unfavorable median forecast, less dispersed beliefs greatly increase default risk; this is consistent with incomplete information models that rely on coordination risk while in contrast with a wide range of models that neglect this component. Second, less dispersion of beliefs amplifies the reaction of default risk to changes in market expectations; importantly, precise information raises banks' vulnerability by more than standard measures of banks' fragility. Taken together, our results suggest that enhanced transparency, by providing agents with more precise information, increases banks' vulnerability to changes in sentiment and raises the default risk of weaker banks. Finally, we address concerns of endogeneity of market expectations by introducing a novel set of instruments.

Keywords: CDS Spread, Coordination Risk, Dispersed Information, Financial Crisis, Global Games

JEL Classification: D83, G01, G21

Suggested Citation

Brancati, Emanuele and Macchiavelli, Marco, The Role of Dispersed Information in Pricing Default: Evidence from the Great Recession (August 13, 2015). FEDS Working Paper No. 2015-079, http://dx.doi.org/10.17016/FEDS.2015.079, Available at SSRN: https://ssrn.com/abstract=2665694 or http://dx.doi.org/10.2139/ssrn.2665694

Emanuele Brancati

Sapienza University of Rome ( email )

via Castro del Laurenziano 9
Roma, IA Rome 00191
Italy

IZA Institute of Labor Economics ( email )

P.O. Box 7240
Bonn, D-53072
Germany

Sapienza University of Rome - Faculty of Economics ( email )

Via del Castro Laurenziano 9
Rome, 00161
Italy

Marco Macchiavelli (Contact Author)

Isenberg School of Management ( email )

Amherst, MA 01003
United States

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