New Riksbank Working Paper version of “A wake-up call theory of contagion”

“A wake-up call theory or contagion” with Toni Ahnert (This version: 03/2020; First version: 06/2012)

  • Abstract: We offer a theory of contagion based on the information choice of investors after observing a financial crisis elsewhere. We study global coordination games of regime change in two regions with an unobserved common macro shock as the only link between regions. A crisis in the first region is a wake-up call to investors in the second region. It induces them to reassess the regional fundamental and acquire information about the macro shock. Contagion can occur even after investors learn that regions are unrelated (zero macro shock). Our results rationalize empirical evidence about contagious bank runs and currency crises after wake-up calls. We also derive other testable implications of the model. (D83, F3, G01, G21)
The value of information v and the proportion of informed investors n2 with and without a wake-up call, f ∈ {1, 0}. The figure shows (1) the strategic complementarity in information choices and (2) the effect of a higher level of s that increases the skewness of the macro shock and leads to an expansion of the intermediate range of information costs for which we establish the wake-up call contagion effect.