“A wake-up call theory or contagion” with Toni Ahnert (Bank of Canada) (This version: January 2015; First version: June 2012).
We propose a novel theory of financial contagion. We study global coordination games of regime change in two regions with an initially uncertain correlation of regional fundamentals. A crisis in region 1 is a wake-up call to investors in region 2 that induces a re-assessment of local fundamentals. Contagion after a wake-up call can occur even if investors learn that fundamentals are uncorrelated and common lender effects or balance sheet linkages are absent. Applicable to currency attacks, bank runs, and debt crises, our theory of contagion is supported by existing evidence and generates a new testable implication for empirical work. (JEL D82, F3, G01)