Fragility of Reputation and Clustering in Risk Taking
AbstractI study the interplay between reputation and risk-taking in a dynamic stochastic environment where it is ex-ante efficient for firms to engage in safe projects, but ex-post preferred to invest in risky ones, appropriating surplus from lenders. By introducing fundamentals, I interpret the model as a dynamic global game in which strategic complementarities arise endogenously from reputation updating, overcoming pervasive multiple equilibria. I find that even though reputation deters opportunistic behavior, it introduces fragile incentives which may lead to large changes in aggregate risk-taking in response to small changes in aggregate fundamentals, inducing financial crises and credit crunches.
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Bibliographic InfoPaper provided by Society for Economic Dynamics in its series 2008 Meeting Papers with number 441.
Date of creation: 2008
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Other versions of this item:
- Ordoñez, Guillermo L., 2013. "Fragility of reputation and clustering of risk-taking," Theoretical Economics, Econometric Society, vol. 8(3), September.
- Guillermo L. Ordoñez, 2009. "Fragility of reputation and clustering of risk-taking," Staff Report 431, Federal Reserve Bank of Minneapolis.
- D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
- E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
- G01 - Financial Economics - - General - - - Financial Crises
- G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
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