Asymmetric Price Movements and Borrowing Constraints: A Rational Expectations Equilibrium Model of Crises, Contagion, and Confusion
This study proposes a rational expectations equilibrium model of crises and contagion in an economy with information asymmetry and borrowing constraints. Consistent with empirical observations, the model finds: (1) Crises can be caused by small shocks to fundamentals; (2) market return distributions are asymmetric; and (3) correlations among asset returns tend to increase during crashes. The model also predicts: (1) Crises and contagion are likely to occur after small shocks in the intermediate price region; (2) the skewness of asset price distributions increases with information asymmetry and borrowing constraints; and (3) crises can spread through investor borrowing constraints. Copyright 2005 by The American Finance Association.
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Volume (Year): 60 (2005)
Issue (Month): 1 (02)
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