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Bubbles and Self-Fulfilling Crises

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  • Challe Edouard

    ()
    (Ecole Polytechnique and Banque de France)

  • Ragot Xavier

    ()
    (Banque de France and PSE)

Abstract

Financial crises are often associated with an endogenous credit reversal followed by a fall in asset prices and serious disruptions in the financial sector. To account for this sequence of events, this paper constructs a model where excessive risk-taking by investors leads to a bubble in asset prices, and where the supply of credit to these investors is endogenous. We show that the interplay between excessive risk-taking and the endogeneity of credit may give rise to multiple equilibria associated with different levels of lending, asset prices, and output. Stochastic equilibria lead, with positive probability, to an inefficient liquidity dry-up, a market crash, and widespread failures by borrowers. The possibility of multiple equilibria and self-fulfilling crises is shown to be related to the severity of the risk-shifting problem in the economy.

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Bibliographic Info

Article provided by De Gruyter in its journal The B.E. Journal of Macroeconomics.

Volume (Year): 11 (2011)
Issue (Month): 1 (May)
Pages: 1-38

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Handle: RePEc:bpj:bejmac:v:11:y:2011:i:1:n:8

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Citations

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Cited by:
  1. Challe, Edouard & Mojon, Benoit & Ragot, Xavier, 2013. "Equilibrium risk shifting and interest rate in an opaque financial system," European Economic Review, Elsevier, vol. 63(C), pages 117-133.
  2. Sylvain Champonnois, 2011. "The limits of market discipline: proprietary trading and aggregate risk," 2011 Meeting Papers 1013, Society for Economic Dynamics.
  3. Dubecq, S. & Mojon, B. & Ragot, X., 2009. "Fuzzy Capital Requirements, Risk-Shifting and the Risk Taking Channel of Monetary Policy," Working papers 254, Banque de France.
  4. repec:hal:psewpa:hal-00719952 is not listed on IDEAS
  5. Petr VALOUCH & Jaroslav SEDLÁCEK & Alois KONECNÝ, 2012. "Analysis of the Behavior Mergermarket in the Conditions the Financial Crisis," Economics and Applied Informatics, "Dunarea de Jos" University of Galati, Faculty of Economics and Business Administration, issue 1, pages 37-44.

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