Panics and Early Warnings

Abstract

We study optimal adversarial information design in a dynamic regime change game. Agents decide when to attack, if at all. We assume (1) delay incurs a continuous cost and (2) agents doubt the correctness of their actions. The game may end in a "disaster" due to weak fundamentals or panic --- agents attacking despite sound fundamentals. We propose a "timely disaster alert" that promptly warns about impending disasters, making waiting for and following the alert the unique rationalizable strategy, thereby eliminating panic. We relate this optimal policy to early warning systems such as bank stress tests and debt sustainability analysis.

Keywords: Adversarial Selection, Dynamic Information Design, Coordination, Stress Test, Regime Change

JEL Classification: D02, D82, D83, G28