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Asymmetric price movements and borrowing constraints: a rational expectations equilibrium model of crises, contagion, and confusion

By Kathy Yuan

Abstract

This study proposes a rational expectations equilibrium model of crises and contagion in an economy with information asymmetry and borrowing constraints. Consistent with empirical observations, the model finds: (1) Crises can be caused by small shocks to fundamentals; (2) market return distributions are asymmetric; and (3) correlations among asset returns tend to increase during crashes. The model also predicts: (1) Crises and contagion are likely to occur after small shocks in the intermediate price region; (2) the skewness of asset price distributions increases with information asymmetry and borrowing constraints; and (3) crises can spread through investor borrowing constraints

Topics: HB Economic Theory, HG Finance
Publisher: Wiley
Year: 2005
OAI identifier: oai:eprints.lse.ac.uk:39405
Provided by: LSE Research Online
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