Lack of preparation for rare events

Bartosz Maćkowiak and Mirko Wiederholt

Journal of Monetary Economics, 2018, vol. 100, issue C, 35-47

Abstract: A new view of crises is proposed: A rare event occurs, consciously unprepared agents take bad actions, and catastrophic consequences follow. We model agents who prepare to act in different contingencies. They can process only a finite amount of information and thus cannot prepare perfectly for all contingencies. In equilibrium, agents equate the probability-weighted expected loss due to suboptimal action across contingencies, implying that the expected loss in a rare event is orders of magnitude larger than in normal times. Limited liability causes even less preparation for rare events and creates inefficiencies.

Keywords: Rare events; Disasters; Rational inattention; Efficiency (search for similar items in EconPapers)
JEL-codes: D83 E58 E60 (search for similar items in EconPapers)
Date: 2018
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Citations: View citations in EconPapers (20)

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Working Paper: Lack of Preparation for Rare Events (2018)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:moneco:v:100:y:2018:i:c:p:35-47

DOI: 10.1016/j.jmoneco.2018.07.007

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