Fragility of Reputation and Clustering in Risk Taking

Guillermo Ordonez

No 441, 2008 Meeting Papers from Society for Economic Dynamics

Abstract: 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.

Date: 2008
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Related works:
Journal Article: Fragility of reputation and clustering of risk-taking (2013)
Working Paper: Fragility of reputation and clustering of risk-taking (2009)
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