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Bubbles and Self-fulfilling Crises

Author

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  • Edouard Challe

    (CNRS-CEREG public)

  • Xavier Ragot

Abstract

Financial crises are often associated with an endogenous credit reversal followed by a fall in asset prices and serious disruptions in the financial sector. To account for this sequence of events, this paper constructs a model where the excessive risk-taking of portfolio investors leads to a bubble in asset prices (in the spirit of Allen and Gale, 'Bubbles and Crises', Economic Journal, 2000), and where the supply of credit to these investors is endogenous. We show that the interplay between the risk shifting problem and the endogeneity of credit may give rise multiple equilibria associated with di¤erent levels of lending, asset prices, and output. Stochastic equilibria lead, with positive probability, to an ine¢ cient liquidity dry-up at the intermediate date, a market crash, and widespread failures of borrowers. The possibility of multiple equilibria and self-fulfilling crises is showed to be related to the severity of the risk shifting problem in the economy

Suggested Citation

  • Edouard Challe & Xavier Ragot, 2006. "Bubbles and Self-fulfilling Crises," 2006 Meeting Papers 254, Society for Economic Dynamics.
    • Handle: RePEc:red:sed006:254
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    Cited by:

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    2. Challe, Edouard & Mojon, Benoit & Ragot, Xavier, 2013. "Equilibrium risk shifting and interest rate in an opaque financial system," European Economic Review, Elsevier, vol. 63(C), pages 117-133.
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    6. Petr VALOUCH & Jaroslav SEDLÁCEK & Alois KONECNÝ, 2012. "Analysis of the Behavior Mergermarket in the Conditions the Financial Crisis," Economics and Applied Informatics, "Dunarea de Jos" University of Galati, Faculty of Economics and Business Administration, issue 1, pages 37-44.
    7. Dubecq, S. & Mojon, B. & Ragot, X., 2009. "Fuzzy Capital Requirements, Risk-Shifting and the Risk Taking Channel of Monetary Policy," Working papers 254, Banque de France.

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    More about this item

    Keywords

    Credit market imperfections; self-fulfilling expectations; financial crises.;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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