Information Acquisition, Coordination, and Fundamentals in a Financial Crisis
Higher School of Economics
This paper reconciles the two explanations of a financial crisis, the self-fulfilling prophecy and the fundamental causes, in an empirically-relevant framework, by explicitly modeling the costly voluntary acquisition of information about fundamentals in a variant of Diamond and Dybvig (1983). In the run equilibrium, investors engage in costly evaluation of projects, so that banks with lower-return projects fail. In the no-run equilibrium, there is no project evaluation. Investors' coordination on a specific equilibrium is triggered by a self-fulfilling prophecy. So, financial crises are seen as both, fundamentals-based and self-fulfilling prophecies-based phenomena.
Number of Pages in PDF File: 11
Keywords: Financial crisis, banks, self-fulfilling prophecy
JEL Classification: F34, G21, G31
Date posted: November 30, 2004