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Information acquisition, coordination, and fundamentals in a financial crisis

  • Nikitin, Maxim
  • Smith, R. Todd

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 [Diamond, D., Dybvig, P., 1983. Bank runs, deposit insurance, and liquidity. Journal of Political Economy 91, 401-419]. The model exhibits strategic complementarity in information acquisition. In the "partial run" equilibrium investors engage in costly evaluation of projects, so that banks with lower-return projects fail. There also exist the classic "full-run" and "no-run" equilibria in which 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.

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Article provided by Elsevier in its journal Journal of Banking & Finance.

Volume (Year): 32 (2008)
Issue (Month): 6 (June)
Pages: 907-914

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Handle: RePEc:eee:jbfina:v:32:y:2008:i:6:p:907-914
Contact details of provider: Web page: http://www.elsevier.com/locate/jbf

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  1. Roberto Chang & Andres Velasco, 1997. "Financial fragility and the exchange rate regime," Working Paper 97-16, Federal Reserve Bank of Atlanta.
  2. Morris, S & Song Shin, H, 1996. "Unique Equilibrium in a Model of Self-Fulfilling Currency Attacks," Economics Papers 126, Economics Group, Nuffield College, University of Oxford.
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