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Fragility of Reputation and Clustering in Risk Taking

  • Guillermo Ordonez

    (UCLA)

I study the interplay between reputation and risk-taking in a dynamic stochastic environment where it is ex-ante efficient for firms to engage in safe projects, but ex-post preferred to invest in risky ones, appropriating surplus from lenders. By introducing fundamentals, I interpret the model as a dynamic global game in which strategic complementarities arise endogenously from reputation updating, overcoming pervasive multiple equilibria. I find that even though reputation deters opportunistic behavior, it introduces fragile incentives which may lead to large changes in aggregate risk-taking in response to small changes in aggregate fundamentals, inducing financial crises and credit crunches.

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Paper provided by Society for Economic Dynamics in its series 2008 Meeting Papers with number 441.

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Date of creation: 2008
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Handle: RePEc:red:sed008:441
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Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

Web page: http://www.EconomicDynamics.org/society.htm
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