Working Paper: NBER ID: w11015
Authors: georgemarios angeletos; ivan werning
Abstract: Many argue that crises -- such as currency attacks, bank runs and riots -- can be described as times of non-fundamental volatility. We argue that crises are also times when endogenous sources of information are closely monitored and thus an important part of the phenomena. We study the role of endogenous information in generating volatility by introducing a financial market in a coordination game where agents have heterogeneous information about the fundamentals. The equilibrium price aggregates information without restoring common knowledge. In contrast to the case with exogenous information, we find that uniqueness may not be obtained as a perturbation from common knowledge: multiplicity is ensured when individuals observe fundamentals with small idiosyncratic noise. Multiplicity may emerge also in the financial price. When the equilibrium is unique, it becomes more sensitive to non-fundamental shocks as private noise is reduced.
Keywords: crises; information aggregation; multiplicity; volatility
JEL Codes: D8; E5; F3; G1
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| endogenous information (D83) | price volatility (G13) |
| small idiosyncratic noise (D89) | multiplicity of equilibria (C62) |
| decrease in private noise (R41) | increased sensitivity to nonfundamental shocks (E39) |
| lower noise (Y50) | increased volatility (E32) |
| improved private information (D82) | more precise public information (D89) |
| more precise public information (D89) | affected agents' behavior (D91) |
| information structure (L15) | volatility of outcomes during crises (E32) |