We develop a theory of endogenous uncertainty where the ability of investors to learn about firm-level fundamentals declines during financial crises. At the same time, higher uncertainty reinforces financial distress, causing a persistent cycle of uncertainty, pessimistic expectations, and financial constraints. Through this channel, a temporary shortage of funds can develop into a long-lasting funding problem for firms. Financial crises are characterized by increased credit misallocation, volatile asset prices, high risk premia, an increased cross-sectional dispersion of returns, and high levels of disagreement among forecasters. A numerical example suggests that the proposed channel may significantly delay recovery from financial shocks.
Belief traps; credit crunches; dispersed information; endogenous uncertainty; internal persistence of financial shocks; resource misallocation;
- D83: Search • Learning • Information and Knowledge • Communication • Belief
- E32: Business Fluctuations • Cycles
- E44: Financial Markets and the Macroeconomy
TSE Working Paper, n. 15-604, October 1, 2015, revised December 2017