Reference

Ludwig Straub, and Robert Ulbricht, "Endogenous Uncertainty and Credit Crunches", TSE Working Paper, n. 15-604, October 1, 2015.

Abstract

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 of firms, giving rise to “belief traps”— a persistent cycle of uncertainty, pessimistic expectations, and financial constraints, through which a temporary shortage of funds can develop into a long-lasting funding problem for firms. At the macro-level, belief traps provide a rationale for the long-lasting recessions that typically entail financial crises. In our model, financial crises are characterized by high levels of credit misallocation, an increased cross-sectional dispersion of growth rates, endogenously increased pessimism, uncertainty and disagreement among investors, highly volatile asset prices, and high risk premia. A calibration of our model to U.S. micro data on investor beliefs matches the slow recovery after the 08/09 crisis remarkably well.

Keywords

Belief traps; credit crunches; dispersed information; endogenous uncertainty; internal persistence of financial shocks; resource misallocation;

JEL codes

  • D83: Search • Learning • Information and Knowledge • Communication • Belief
  • E32: Business Fluctuations • Cycles
  • E44: Financial Markets and the Macroeconomy