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.
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- 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.
- Viral V. Acharya & Douglas Gale & Tanju Yorulmazer, 2010. "Rollover Risk and Market Freezes," NBER Working Papers 15674, National Bureau of Economic Research, Inc.
- Glaeser, Edward Ludwig & Laibson, David I. & Scheinkman, Jose A. & Soutter, Christine L., 2000.
4481497, Harvard University Department of Economics.
- Ricardo J. Caballero & Alp Simsek, 2009. "Complexity and Financial Panics," NBER Working Papers 14997, National Bureau of Economic Research, Inc.
- Christian Upper, 2007. "Using counterfactual simulations to assess the danger of contagion in interbank markets," BIS Working Papers 234, Bank for International Settlements.
When requesting a correction, please mention this item's handle: RePEc:arx:papers:0911.3099. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (arXiv administrators)
If references are entirely missing, you can add them using this form.