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Crises: Equilibrium Shifts and Large Shocks

39 Pages Posted: 16 Dec 2016  

Stephen Morris

Princeton University - Department of Economics

Muhamet Yildiz

Massachusetts Institute of Technology (MIT) - Department of Economics

Date Written: November 30, 2016

Abstract

A coordination game with incomplete information is played through time. In each period, payoffs depend on a fundamental state and an additional idiosyncratic shock. Fundamentals evolve according to a random walk where the changes in fundamentals (namely common shocks) have a fat tailed distribution. We show that majority play shifts either if fundamentals reach a critical threshold or if there are large common shocks, even before the threshold is reached. The fat tails assumption matters because it implies that large shocks make players more unsure about whether their payoffs are higher than others. This feature is necessary for large shocks to matter.

Keywords: Equilibrium Shift; Global Games; Rank Beliefs; Fat Tails; Hysteresis; Equilibrium Selection; Multiple Equilibria

JEL Classification: C72, D82, E32

Suggested Citation

Morris, Stephen and Yildiz, Muhamet, Crises: Equilibrium Shifts and Large Shocks (November 30, 2016). MIT Department of Economics Working Paper No. 16-13. Available at SSRN: https://ssrn.com/abstract=2885460 or http://dx.doi.org/10.2139/ssrn.2885460

Stephen Edward Morris

Princeton University - Department of Economics ( email )

Princeton, NJ 08544-1021
United States

Muhamet Yildiz (Contact Author)

Massachusetts Institute of Technology (MIT) - Department of Economics ( email )

50 Memorial Drive
Room E52-522
Cambridge, MA 02142
United States
617-253-5331 (Phone)
617-253-6915 (Fax)

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