Uncertain Booms and Fragility
51 Pages Posted: 23 Jul 2018
Date Written: July 2, 2018
I develop a framework of the buildup and outbreak of financial crises in an asymmetric information setting. In equilibrium, two distinct economic states arise endogenously: “normal times,” periods of modest investment, and “booms,” periods of expansionary investment. Normal times occur when the intermediary sector realizes moderate investment opportunities. Booms occur when the intermediary sector realizes many investment opportunities, but also occur when it realizes very few opportunities. As a result, investors face greater uncertainty in booms. During a boom, subsequent arrival of negative information about an intermediary asset results in large downward shifts in investors’ confidence about the underlying quality of long-term assets. A crisis of confidence ensues. Investors collectively force costly early liquidation of the intermediated assets and move capital to safe assets, in a flight-to-quality episode.
Keywords: financial crises, financial intermediation, asymmetric information, booms, financial fragility
JEL Classification: D82, E02, G01
Suggested Citation: Suggested Citation