Coordination Failure and Financial Contagion

Michael Manz

Diskussionsschriften from Universitaet Bern, Departement Volkswirtschaft

Abstract: This paper explores a unique equilibrium model of ''informational'' financial contagion. Extending the global game model of Morris and Shin (1999), I show that the failure of a single firm can trigger a chain of failures merely by affecting the behavior of investors. In contrast to the existing multiple equilibria models of financial and banking panics, there is no indeterminacy in the present model. Thus, it provides a clear framework to assess the consequences of contagion and yields some important and hitherto unnoticed insights. Most importantly, if contagion is compared to an appropriate benchmark, its impact can be both positive or negative, which contrasts sharply with the traditional view of contagion. Moreover, contagion increases the correlation between firms, but the effect on the unconditional probability of failure is exactly zero

Keywords: financial contagion; systemic risk; financial crises; global games; unique equilibrium (search for similar items in EconPapers)
JEL-codes: C72 G15 G21 (search for similar items in EconPapers)
Date: 2002-03
New Economics Papers: this item is included in nep-ifn
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Citations: View citations in EconPapers (4)

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Persistent link: https://EconPapers.repec.org/RePEc:ube:dpvwib:dp0203

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