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Self-Fulfilling Risk Panics

  • Philippe Bacchetta
  • Cédric Tille
  • Eric van Wincoop

Recent crises have seen large spikes in asset price risk. We propose an explanation for such panics based on self-fulfilling shifts in beliefs about risk. A negative link between the current level and the future risk of an asset price leads to a circular relationship between the stochastic process of asset price risk and the price itself. Self-fulfilling shifts in perceived risk can be coordinated around a pure sunspot or around a macro fundamental. In a risk panic, a macro fundamental can be a focal point that affects both the magnitude of the panic and subsequent shifts in perceived risk.

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File URL: http://www.aeaweb.org/articles.php?doi=10.1257/aer.102.7.3674
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Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 102 (2012)
Issue (Month): 7 (December)
Pages: 3674-3700

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Handle: RePEc:aea:aecrev:v:102:y:2012:i:7:p:3674-3700
Note: DOI: 10.1257/aer.102.7.3674
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