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Coordination Failure and Financial Contagion

  • Michael Manz
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    This paper explores a unique equilibrium model of ''informational'' financial contagion. Extending the global game model of Morris and Shin (1999), I show that the failure of a single firm can trigger a chain of failures merely by affecting the behavior of investors. In contrast to the existing multiple equilibria models of financial and banking panics, there is no indeterminacy in the present model. Thus, it provides a clear framework to assess the consequences of contagion and yields some important and hitherto unnoticed insights. Most importantly, if contagion is compared to an appropriate benchmark, its impact can be both positive or negative, which contrasts sharply with the traditional view of contagion. Moreover, contagion increases the correlation between firms, but the effect on the unconditional probability of failure is exactly zero

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    File URL: http://www.vwl.unibe.ch/papers/dp/dp0203.pdf
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    Paper provided by Universitaet Bern, Departement Volkswirtschaft in its series Diskussionsschriften with number dp0203.

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    Date of creation: Mar 2002
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    Handle: RePEc:ube:dpvwib:dp0203
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    1. Morris, Stephen & Shin, Hyun Song, 1998. "Unique Equilibrium in a Model of Self-Fulfilling Currency Attacks," American Economic Review, American Economic Association, vol. 88(3), pages 587-97, June.
    2. Rubinstein, Ariel, 1989. "The Electronic Mail Game: Strategic Behavior under "Almost Common Knowledge."," American Economic Review, American Economic Association, vol. 79(3), pages 385-91, June.
    3. Allen, Franklin & Gale, Douglas, 1998. "Financial Contagion," Working Papers 98-33, C.V. Starr Center for Applied Economics, New York University.
    4. Carlsson, H. & van Damme, E.E.C., 1993. "Global games and equilibrium selection," Other publications TiSEM 49a54f00-dcec-4fc1-9488-4, Tilburg University, School of Economics and Management.
    5. Rochet, Jean-Charles & Vives, Xavier, 2002. "Coordination failures and the lender of last resort : was Bagehot right after all?," HWWA Discussion Papers 184, Hamburg Institute of International Economics (HWWA).
    6. Maurice Obstfeld, 1995. "Models of Currency Crises with Self-Fulfilling Features," NBER Working Papers 5285, National Bureau of Economic Research, Inc.
    7. David M. Frankel & Stephen Morris & Ady Pauzner, 2000. "Equilibrium Selection in Global Games with Strategic Complementarities," Econometric Society World Congress 2000 Contributed Papers 1490, Econometric Society.
    8. Barry Eichengreen & Andrew K. Rose & Charles Wyplosz, 1996. "Contagious Currency Crises," NBER Working Papers 5681, National Bureau of Economic Research, Inc.
    9. Rochet, Jean-Charles & Tirole, Jean, 1996. "Interbank Lending and Systemic Risk," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 28(4), pages 733-62, November.
    10. Stephen Morris & Hyun Song Shin, 2001. "Coordination risk and the price of debt," LSE Research Online Documents on Economics 25046, London School of Economics and Political Science, LSE Library.
    11. Aharony, Joseph & Swary, Itzhak, 1996. "Additional evidence on the information-based contagion effects of bank failures," Journal of Banking & Finance, Elsevier, vol. 20(1), pages 57-69, January.
    12. Stephen Morris & Hyun S Shin, 2001. "Global Games: Theory and Applications," Levine's Working Paper Archive 122247000000001080, David K. Levine.
    13. Park, Sangkyun, 1991. "Bank failure contagion in historical perspective," Journal of Monetary Economics, Elsevier, vol. 28(2), pages 271-286, October.
    14. Postlewaite, Andrew & Vives, Xavier, 1987. "Bank Runs as an Equilibrium Phenomenon," Journal of Political Economy, University of Chicago Press, vol. 95(3), pages 485-91, June.
    15. Sangkyun Park, 1991. "Bank failure contagion in historical perspective," Research Paper 9103, Federal Reserve Bank of New York.
    16. Dornbusch, Rudiger & Park, Yung Chul & Claessens, Stijn, 2000. "Contagion: Understanding How It Spreads," World Bank Research Observer, World Bank Group, vol. 15(2), pages 177-97, August.
    17. Yehning Chen, 1999. "Banking Panics: The Role of the First-Come, First-Served Rule and Information Externalities," Journal of Political Economy, University of Chicago Press, vol. 107(5), pages 946-968, October.
    18. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
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