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Endogenous Uncertainty and Credit Crunches

Ludwig Straub and Robert Ulbricht

No 15-604, TSE Working Papers from Toulouse School of Economics (TSE)

Abstract: We develop a theory of endogenous uncertainty where the ability of investors to learn about firm-level fundamentals declines during financial crises. At the same time, higher uncertainty reinforces financial distress, causing a persistent cycle of uncertainty, pessimistic expectations, and financial constraints. Through this channel, a temporary shortage of funds can develop into a long-lasting funding problem for firms. Financial crises are characterized by increased credit misallocation, volatile asset prices, high risk premia, an increased cross-sectional dispersion of returns, and high levels of disagreement among forecasters. A numerical example suggests that the proposed channel may significantly delay recovery from financial shocks.

Keywords: Belief traps; credit crunches; dispersed information; endogenous uncertainty; internal persistence of financial shocks; resource misallocation (search for similar items in EconPapers)
JEL-codes: D83 E32 E44 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge and nep-mac
Date: 2015-10, Revised 2017-12
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