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Bubbles and self fulfilling crisis

Edouard Challe () and Xavier Ragot ()

Sciences Po publications from Sciences Po

Abstract: Financial crises are often associated with an endogenous credit reversal followed by a fall in asset prices and serious disruptions in the financial sector. To account for this sequence of events, this paper constructs a model where excessive risk-taking by investors leads to a bubble in asset prices, and where the supply of credit to these investors is endogenous. We show that the interplay between excessive risk-taking and the endogeneity of credit may give rise to multiple equilibria associated with different levels of lending, asset prices, and output. Stochastic equilibria lead, with positive probability, to an inefficient liquidity dry-up, a market crash, and widespread failures by borrowers. The possibility of multiple equilibria and self-fulfilling crises is shown to be related to the severity of the risk-shifting problem in the economy.

Keywords: Market imperfections; Self fulfilling expectations; Financial crisis (search for similar items in EconPapers)
Date: 2011-05
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Published in B.E Journal of Macroeconomics, 2011, vol. 11, pp.1-36

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Related works:
Journal Article: Bubbles and Self-Fulfilling Crises (2011) Downloads
Working Paper: Bubbles and Self-Fulfilling Crises (2011)
Working Paper: Bubbles and self-fulfilling crises (2007) Downloads
Working Paper: Bubbles and Self-fulfilling Crises (2006) Downloads
Working Paper: Bubbles and self fullfilling crisis (2005) Downloads
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