TY  - JOUR
AU  - Caballero,Ricardo J.
AU  - Simsek,Alp
TI  - Complexity and Financial Panics
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 14997
PY  - 2009
Y2  - May 2009
UR  - http://www.nber.org/papers/w14997
L1  - http://www.nber.org/papers/w14997.pdf
N1  - Author contact info:
Ricardo J. Caballero
MIT
Department of Economics
Room E52-373a
Cambridge, MA 02142-1347
Tel: 617/253-0489
Fax: 617/253-6915
E-Mail: caball@mit.edu

Alp Simsek
Department of Economics
Harvard University
Littauer Center 319
Cambridge, Ma. 02138
Tel: 617/496-3374
Fax: 617/495-7730
E-Mail: asimsek@fas.harvard.edu
AB  - During extreme financial crises, all of a sudden, the financial world that was once rife with profit opportunities for financial institutions (banks, for short) becomes exceedingly complex. Confusion and uncertainty follow, ravaging financial markets and triggering massive flight-to-quality episodes. In this paper we propose a model of this phenomenon. In our model, banks normally collect information about their trading partners which assures them of the soundness of these relationships. However, when acute financial distress emerges in parts of the financial network, it is not enough to be informed about these partners, as it also becomes important to learn about the health of their trading partners. As conditions continue to deteriorate, banks must learn about the health of the trading partners of the trading partners of the trading partners, and so on. At some point, the cost of information gathering becomes too unmanageable for banks, uncertainty spikes, and they have no option but to withdraw from loan commitments and illiquid positions. A flight-to-quality ensues, and the financial crisis spreads.
ER  -