Endogenous Uncertainty and Credit Crunches

34 Pages Posted: 1 Oct 2015 Last revised: 26 Dec 2017

See all articles by Ludwig Straub

Ludwig Straub

Massachusetts Institute of Technology (MIT), Department of Economics, Students

Robert Ulbricht

Toulouse School of Economics

Date Written: December 25, 2017

Abstract

We develop a theory of endogenous uncertainty where the ability of investors to learn about firm-level fundamentals declines during financial crises. At the same time, higher uncertainty reinforces financial distress, causing a persistent cycle of uncertainty, pessimistic expectations, and financial constraints. Through this channel, a temporary shortage of funds can develop into a long-lasting funding problem for firms. Financial crises are characterized by increased credit misallocation, volatile asset prices, high risk premia, an increased cross-sectional dispersion of returns, and high levels of disagreement among forecasters. A numerical example suggests that the proposed channel may significantly delay recovery from financial shocks.

Keywords: Belief traps, credit crunches, dispersed information, endogenous uncertainty, internal persistence of financial shocks, resource misallocation

JEL Classification: D83, E32, E44, G01

Suggested Citation

Straub, Ludwig and Ulbricht, Robert, Endogenous Uncertainty and Credit Crunches (December 25, 2017). Available at SSRN: https://ssrn.com/abstract=2668078 or http://dx.doi.org/10.2139/ssrn.2668078

Ludwig Straub

Massachusetts Institute of Technology (MIT), Department of Economics, Students ( email )

Cambridge, MA
United States

Robert Ulbricht (Contact Author)

Toulouse School of Economics ( email )

Manufacture de Tabacs
21 allées de Brienne
Toulouse, 31015
France

HOME PAGE: http://sites.google.com/site/ulbrichtrob/

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