Information Choice and Amplification of Financial Crises

Abstract

We propose an amplification mechanism of financial crises based on the information choice of investors. Adverse news about the solvency of a debtor raises the value of private information and therefore induces the acquisition of information. Informed investors rely more on private information and refuse to roll over debt more often than uninformed investors. This amplifies the probability of a debt crisis. To enhance financial stability, a policymaker can use taxes and subsidies to affect information acquisition. We also derive implications about the magnitude of amplification and discuss how these can be tested.

Keywords: amplification, financial crises, global games, information choice

JEL Classification: D83, G01