Financial crises and the evaporation of trust
Trust lies at the crux of most economic transactions, with credit markets being a notable example. Drawing on insights from the literature on coordination games and network growth, we develop a simple model to clarify how trust breaks down in financial systems. We show how the arrival of bad news about a financial agent can lead others to lose confidence in it and how this, in turn, can spread across the entire system. Our results emphasize the role of hysteresis -- it takes considerable effort to regain trust once it has been broken. Although simple, the model provides a plausible account of the credit freeze that followed the global financial crisis of 2007/8, both in terms of the sequence of events and the measures taken (and being proposed) by the authorities.
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- Viral V. Acharya & Douglas Gale & Tanju Yorulmazer, 2011.
"Rollover Risk and Market Freezes,"
Journal of Finance,
American Finance Association, vol. 66(4), pages 1177-1209, 08.
- Acharya, Viral V & Gale, Douglas M & Yorulmazer, Tanju, 2009. "Rollover Risk and Market Freezes," CEPR Discussion Papers 7122, C.E.P.R. Discussion Papers.
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- Viral V. Acharya & Douglas Gale & Tanju Yorulmazer, 2010. "Rollover Risk and Market Freezes," NBER Working Papers 15674, National Bureau of Economic Research, Inc.
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- Christian Upper, 2007. "Using counterfactual simulations to assess the danger of contagion in interbank markets," BIS Working Papers 234, Bank for International Settlements. Full references (including those not matched with items on IDEAS)
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