A Wake-Up Call Theory of Contagion
72 Pages Posted: 4 May 2022
There are 2 versions of this paper
A Wake-Up Call Theory of Contagion
A Wake-Up Call Theory of Contagion
Date Written: May 1, 2022
Abstract
We offer a theory of financial contagion based on the information choice of investors after observing a financial crisis elsewhere. We study global coordination games of regime change in two regions linked by an initially unobserved macro shock. A crisis in region 1 is a wake-up call to investors in region 2. It induces them to reassess the regional fundamental and acquire information about the macro shock. Contagion can occur even after investors learn that region 2 has no ex-post exposure to region 1. We explore normative and testable implications of the model. In particular, our results rationalize evidence about contagious currency crises and bank runs after wake-up calls and provide some guidance for future empirical work.
Keywords: bank run, contagion, financial crises, fundamental re-assessment., global games, information choice, wake-up call
JEL Classification: D83, F3, G01, G21
Suggested Citation: Suggested Citation