IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Login to save this paper or follow this series

Self-Fulfilling Risk Panics

  • Bacchetta, Philippe

    (University of Lausanne, CEPR)

  • Tille, Cédric

    (Graduate Institute, Geneva, CEPR)

  • Wincoop, Eric

    (University of Virginia, NBER)

Recent crises have seen large spikes in asset price risk without dramatic shifts in fundamentals. We propose an explanation for these risk panics, based on selfful filling shifts in beliefs about risk, that are driven by a negative link between the current asset price and risk about the future asset price. This link implies that risk about the future asset price depends on uncertainty about future risk. This dynamic mapping of risk into itself gives rise to the possibility of multiple equilibria and can generate risk panics. In a panic, risk beliefs are coordinated around a macro fundamental that becomes a sudden focal point of the market. The magnitude of the panic is larger the weaker this macro fundamental. The sharp increase in risk leads to a large drop in the asset price, decreased leverage and reduced market liquidity. While the model is not aimed at modeling the specifics of any particular financial crisis, we show that its implications are broadly consistent with what happened during the 2007-2008 crisis.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://www.bcrp.gob.pe/docs/Publicaciones/Documentos-de-Trabajo/2011/Documento-de-Trabajo-03-2011.pdf
File Function: Application/pdf
Download Restriction: no

Paper provided by Banco Central de Reserva del Perú in its series Working Papers with number 2011-003.

as
in new window

Length:
Date of creation: Feb 2011
Date of revision:
Handle: RePEc:rbp:wpaper:2011-003
Contact details of provider: Postal: Jr. Miro Quesada 441, Lima
Phone: 427-6250 ext. 3841
Fax: 426-6125
Web page: http://www.bcrp.gob.pe

More information through EDIRC

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.:

as in new window
  1. Acharya, Viral V & Pedersen, Lasse Heje, 2004. "Asset Pricing with Liquidity Risk," CEPR Discussion Papers 4718, C.E.P.R. Discussion Papers.
  2. Albert S. Kyle, 2001. "Contagion as a Wealth Effect," Journal of Finance, American Finance Association, vol. 56(4), pages 1401-1440, 08.
  3. Barro, Robert, 2006. "Rare Disasters and Asset Markets in the Twentieth Century," Scholarly Articles 3208215, Harvard University Department of Economics.
  4. Olivier Jeanne & Andrew K. Rose, 1999. "Noise Trading and Exchange Rate Regimes," NBER Working Papers 7104, National Bureau of Economic Research, Inc.
  5. Philippe Aghion & Philippe Bacchetta & Abhijit Banerjee, 2001. "A Corporate Balance-Sheet Approach to Currency Crises," Cahiers de Recherches Economiques du Département d'Econométrie et d'Economie politique (DEEP) 01.14, Université de Lausanne, Faculté des HEC, DEEP.
  6. Xavier Gabaix, 2008. "Variable Rare Disasters: An Exactly Solved Framework for Ten Puzzles in Macro-Finance," NBER Working Papers 13724, National Bureau of Economic Research, Inc.
  7. Dimitri Vayanos & Jiang Wang, 2009. "Liquidity and Asset Prices: A Unified Framework," FMG Discussion Papers dp639, Financial Markets Group.
  8. Zhiguo He & Arvind Krishnamurthy, 2008. "A Model of Capital and Crises," NBER Working Papers 14366, National Bureau of Economic Research, Inc.
  9. Jean-Pierre Zigrand & Hyun Song Shin & Jon Danielsson, 2010. "Risk Appetite and Endogenous Risk," FMG Discussion Papers dp647, Financial Markets Group.
  10. Suleyman Basak & Georgy Chabakauri, 2010. "Dynamic Mean-Variance Asset Allocation," Review of Financial Studies, Society for Financial Studies, vol. 23(8), pages 2970-3016, August.
  11. Allen, Franklin & Gale, Douglas, 1994. "Limited Market Participation and Volatility of Asset Prices," American Economic Review, American Economic Association, vol. 84(4), pages 933-55, September.
  12. Eric van Wincoop & Philippe Bacchetta, 2003. "Can Information Heterogeneity Explain the Exchange Rate Determination Puzzle?," NBER Working Papers 9498, National Bureau of Economic Research, Inc.
  13. Gromb, Denis & Vayanos, Dimitri, 2001. "Equilibrium and Welfare in Markets with Financially Constrained Arbitrageurs," CEPR Discussion Papers 3049, C.E.P.R. Discussion Papers.
  14. Campbell, Rachel & Huisman, Ronald & Koedijk, Kees, 2001. "Optimal portfolio selection in a Value-at-Risk framework," Journal of Banking & Finance, Elsevier, vol. 25(9), pages 1789-1804, September.
  15. Nicholas Bloom, 2007. "The Impact of Uncertainty Shocks," NBER Working Papers 13385, National Bureau of Economic Research, Inc.
  16. Spear, Stephen E. & Srivastava, Sanjay & Woodford, Michael, 1990. "Indeterminacy of stationary equilibrium in stochastic overlapping generations models," Journal of Economic Theory, Elsevier, vol. 50(2), pages 265-284, April.
  17. Brunnermeier, Markus K & Pedersen, Lasse Heje, 2007. "Market Liquidity and Funding Liquidity," CEPR Discussion Papers 6179, C.E.P.R. Discussion Papers.
  18. Ricardo J. Caballero & Arvind Krishnamurthy, 2007. "Collective Risk Management in a Flight to Quality Episode," NBER Working Papers 12896, National Bureau of Economic Research, Inc.
  19. Manuelli, Rodolfo & Peck, James, 1992. "Sunspot-like effects of random endowments," Journal of Economic Dynamics and Control, Elsevier, vol. 16(2), pages 193-206, April.
  20. McCafferty, Stephen & Driskill, Robert, 1980. "Problems of Existence and Uniqueness in Nonlinear Rational Expectations Models," Econometrica, Econometric Society, vol. 48(5), pages 1313-17, July.
  21. Zhiguo He & Arvind Krishnamurthy, 2008. "Intermediary Asset Pricing," NBER Working Papers 14517, National Bureau of Economic Research, Inc.
  22. John Geanakoplos & Ana Fostel, 2008. "Leverage Cycles and the Anxious Economy," American Economic Review, American Economic Association, vol. 98(4), pages 1211-44, September.
  23. Pagano, Marco, 1986. "Endogenous Market Thinness and Stock Price Volatility," CEPR Discussion Papers 146, C.E.P.R. Discussion Papers.
  24. Xavier Gabaix, 2008. "Variable Rare Disasters: A Tractable Theory of Ten Puzzles in Macro-finance," American Economic Review, American Economic Association, vol. 98(2), pages 64-67, May.
  25. Tobias Adrian & Hyun Song Shin, 2008. "Financial intermediary leverage and value at risk," Staff Reports 338, Federal Reserve Bank of New York.
  26. Goyenko, Ruslan Y. & Holden, Craig W. & Trzcinka, Charles A., 2009. "Do liquidity measures measure liquidity?," Journal of Financial Economics, Elsevier, vol. 92(2), pages 153-181, May.
  27. Xiong, Wei, 2001. "Convergence trading with wealth effects: an amplification mechanism in financial markets," Journal of Financial Economics, Elsevier, vol. 62(2), pages 247-292, November.
  28. Walker, Todd B. & Whiteman, Charles H., 2007. "Multiple equilibria in a simple asset pricing model," Economics Letters, Elsevier, vol. 97(3), pages 191-196, December.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:rbp:wpaper:2011-003. 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: (Research Unit)

The email address of this maintainer does not seem to be valid anymore. Please ask Research Unit to update the entry or send us the correct address

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.