Uncertain Booms and Fragility

51 Pages Posted: 23 Jul 2018

See all articles by Michael Junho Lee

Michael Junho Lee

Federal Reserve Banks - Federal Reserve Bank of New York

Date Written: July 2, 2018

Abstract

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

Lee, Michael Junho, Uncertain Booms and Fragility (July 2, 2018). FRB of New York Staff Report No. 861. Available at SSRN: https://ssrn.com/abstract=3218351 or http://dx.doi.org/10.2139/ssrn.3218351

Michael Junho Lee (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

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