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Endogenous Uncertainty and Credit Crunches

Author

Listed:
  • Robert Ulbricht

    (Toulouse School of Economics)

  • Ludwig Straub

    (MIT)

Abstract

This paper examines the relationship between uncertainty and financial crises. In particular, we present a model where the amount of funding a firm receives depends on how financial markets assess the firm's business conditions. Financial agents endogenously learn about a firm's business conditions from local business indicators, but financial constraints impair the usefulness of this information when a firm is short of funds. This is because financially constrained firms respond less to their private information, reducing the informativeness of business indicators. As a result, a temporary aggregate shock to the economy's financial capacity causes a persistent cycle of uncertainty and financial constraints, where financial markets grow increasingly uncertain about firms without funding. While this feedback loop bears little effect on firms with access to funds, the severe effects it has on constrained firms generate a deep and long-lasting aggregate recession, characterized by an increased misallocation of credit, an increased cross-sectional dispersion of output across firms, and highly volatile and pessimistic financial markets.

Suggested Citation

  • Robert Ulbricht & Ludwig Straub, 2015. "Endogenous Uncertainty and Credit Crunches," 2015 Meeting Papers 199, Society for Economic Dynamics.
  • Handle: RePEc:red:sed015:199
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    More about this item

    JEL classification:

    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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