TY  - JOUR
AU  - Bacchetta,Philippe
AU  - Tille,Cédric
AU  - Wincoop,Eric van
TI  - Self-Fulfilling Risk Panics
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 16159
PY  - 2010
Y2  - July 2010
UR  - http://www.nber.org/papers/w16159
L1  - http://www.nber.org/papers/w16159.pdf
N1  - Author contact info:
Philippe Bacchetta
Faculty of Business and Economics
University of Lausanne
Extranef
CH-1015 Lausanne
Switzerland
E-Mail: philippe.bacchetta@unil.ch

Cédric Tille
Graduate Institute for International
and Development Studies
Department of Economics
Pavillon Rigot, Avenue de la Paix 11 A
1202 Geneve, Switzerland
Tel: 41229085928
Fax: 41227333049
E-Mail: cedric.tille@graduateinstitute.ch

Eric van Wincoop
Department of Economics
University of Virginia
P.O. Box 400182
Charlottesville, VA  22904-4182
Tel: 434/924-3997
Fax: 434/982-2904
E-Mail: vanwincoop@virginia.edu
AB  - Recent crises have seen very large spikes in asset price risk without dramatic shifts in fundamentals. We propose an explanation for these risk panics based on self-fulfilling shifts in risk made possible by a negative link between the current asset price and risk about the future asset price. This link implies that risk about tomorrow's asset price depends on uncertainty about risk tomorrow. This dynamic mapping of risk into itself gives rise to the possibility of multiple equilibria and self-fulfilling shifts in risk. We show that this can generate risk panics. The impact of the panic is larger when the shift from a low to a high risk equilibrium takes place in an environment of weak fundamentals. The sharp increase in risk leads to a large drop in the asset price, decreased leverage and reduced market liquidity. We show that the model can account well for the developments during the recent financial crisis.
ER  -