Forthcoming in the Review of Finance: “A Wake-Up Call Theory of Contagion”

“A wake-up call theory or contagion” with Toni Ahnert

  • Abstract: We offer a theory of financial 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 linked by an initially unobserved macro shock. A crisis in region 1 is a wake-up call to investors in region 2. It induces them to reassess the regional fundamental and acquire information about the macro shock. Contagion can occur even after investors learn that region 2 has no ex-post exposure to region 1. We explore normative and testable implications of the model. In particular, our results rationalize evidence about contagious currency crises and bank runs after wake-up calls and provide some guidance for future empirical work. (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 intermediate range of information costs for which we establish information acquisition only after a wake-up call.
  • Keywords: wake-up call, information choice, financial crises, contagion, bank run, global games, regime change, fundamental re-assessment.