The Information View of Financial Crises

Tri Vi Dang, Gary Gorton and Bengt Holmstrom

No 26074, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Short-term debt that can serve as a medium of exchange is designed to be information insensitive. No one should be tempted to acquire private information to gain an informational advantage in trading that could destabilize the value of the debt. Short-term debt minimizes the incentive to acquire information among all securities of equal value backed by the same underlying asset. These features align with observed practice in money markets (markets for short-term debt). They are also consistent with financial crises occurring periodically. In the information view adopted here, financial crisis can occur when the collateral backing the short-term debt is thought to have lost enough value to raise doubts among the traders that some may acquire private information. The purpose of this paper is to review some of the burgeoning empirical literature that bears on the information view sketched above. We focus on evidence related to three key implications of information insensitive debt: (i) adjustments to external shocks will occur along non-price dimensions (less debt issued, higher haircuts, added collateral, etc); (ii) in a crisis some of the short-term debt turns information sensitive; (iii) money markets feature low transparency as well as purposeful opacity.

JEL-codes: D53 E3 G01 G1 (search for similar items in EconPapers)
Date: 2019-07
New Economics Papers: this item is included in nep-ban and nep-mac
Note: AP CF EFG
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Citations: View citations in EconPapers (8)

Published as Tri Vi Dang & Gary Gorton & Bengt Holmström, 2020. "The Information View of Financial Crises," Annual Review of Financial Economics, vol 12(1), pages 39-65.

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Journal Article: The Information View of Financial Crises (2020)
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