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Bubbles and self fullfilling crisis

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  • Edouard Challe
  • Xavier Ragot

    (ECON - Département d'économie (Sciences Po) - Sciences Po - Sciences Po - CNRS - Centre National de la Recherche Scientifique)

Abstract

Financial crises are often associated with an endogenous credit reversal followed by a fall in asset prices and serious disruptions in the financial sector. To account for this sequence of events, this paper constructs a model where excessive risk-taking by investorsleads to a bubble in asset prices, and where the supply of credit to these investors is endogenous. We show that the interplay between excessive risk-taking and the endogeneity of credit may give rise to multiple equilibria associated with different levels of lending, asset prices, and output. Stochastic equilibria lead, with positive probability, to an inefficient liquidity dry-up, a market crash, and widespread failures by borrowers. The possibility of multipleequilibria and self-fulfilling crises is shown to be related to the severity of the risk-shifting problem in the economy

Suggested Citation

  • Edouard Challe & Xavier Ragot, 2005. "Bubbles and self fullfilling crisis," SciencePo Working papers Main hal-03462262, HAL.
    • Handle: RePEc:hal:spmain:hal-03462262
    Note: View the original document on HAL open archive server: https://sciencespo.hal.science/hal-03462262
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    References listed on IDEAS

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    Cited by:

    1. Simon Dubecq & Benoit Mojon & Xavier Ragot, 2015. "Risk Shifting with Fuzzy Capital Constraints," International Journal of Central Banking, International Journal of Central Banking, vol. 11(1), pages 71-101, January.
    2. repec:spo:wpmain:info:hdl:2441/4901esivjh9o4b9spo98etscoh is not listed on IDEAS
    3. Challe, Edouard & Mojon, Benoit & Ragot, Xavier, 2013. "Equilibrium risk shifting and interest rate in an opaque financial system," European Economic Review, Elsevier, vol. 63(C), pages 117-133.
    4. repec:hal:spmain:info:hdl:2441/4901esivjh9o4b9spo98etscoh is not listed on IDEAS
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    6. Petr VALOUCH & Jaroslav SEDLÁCEK & Alois KONECNÝ, 2012. "Analysis of the Behavior Mergermarket in the Conditions the Financial Crisis," Economics and Applied Informatics, "Dunarea de Jos" University of Galati, Faculty of Economics and Business Administration, issue 1, pages 37-44.
    7. Dubecq, S. & Mojon, B. & Ragot, X., 2009. "Fuzzy Capital Requirements, Risk-Shifting and the Risk Taking Channel of Monetary Policy," Working papers 254, Banque de France.

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    More about this item

    Keywords

    Credit market imperfections; Self fullfilling expectaions; Financial crisis;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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