Article

Asymmetric information: the multiplier effect of financial instability

Source: OAI

ABSTRACT Financial markets and financial intermediation are essential to well-functioning economy. They perform the role of channeling funds to parties that have value creating investment opportunities. However, asymmetric information can seriously impair the process when parties to the financial contract are not fully aware of the risks involved and, as a result, can limit their exposure to financial agreements to prevent themselves from possible losses. Increasing asymmetric information as we explain in the article has a tendency to bring a ripple effect in the financial system. This negative money multiplier then sets the stage until it severely hampers money supply, productive investment opportunities and finally aggregate economic activity. The article introduces the reader with the framework of asymmetric information developed by several authors in the last few decades and builds on the recent financial developments that pose new challenges.

0 0
 · 
1 Bookmark
 · 
247 Views
  • [show abstract] [hide abstract]
    ABSTRACT: We test the hypothesis that the degree of asymmetric information should decrease as financial systems develop, in a panel co-integration framework with annual data for 32 countries. To this end, we extend Barron et al.'s (1998) model to derive a measure of analysts' consensus that takes into account biases and herding in their forecasts. We calculate this measure, which is negatively related to asymmetric information, at the country level, with data from the I/B/E/S Global Aggregates database. In addition, we proxy financial development with the extensive set of indices found in the Word Bank's Financial Development and Structure database. Consistent with expectations, and despite the substantial differences across countries in terms of financial development and the quality of the institutional framework, the measure of analysts' consensus is positively related to indices proxying for the development of the financial system.
    02/2008;
  • Source
    [show abstract] [hide abstract]
    ABSTRACT: This paper examines the effects of the financial crisis of the 1930s onthe path of aggregate output during that period. Our approach is complementary to that of Friedman and Schwartz, who emphasized the monetary impact of the bank failures; we focus on non-monetary (primarily credit-related) aspects of the financial sector--output link and consider the problems of debtors as well as those of the banking system. We argue that the financial disruptions of 1930-33 reduced the efficiency of the credit allocation process; and that the resulting higher cost and reduced availability of credit acted to depress aggregate demand. Evidence suggests that effects of this type can help explain the unusual length and depth of the Great Depression.
    02/1983;
  • Source
    [show abstract] [hide abstract]
    ABSTRACT: We introduce adaptive learning behavior into a general-equilibrium life-cycle economy with capital accumulation. Agents form forecasts of the rate of return to capital assets using least-squares autoregressions on past data. We show that, in contrast to the perfect-foresight dynamics, the dynamical system under learning possesses equilibria that are characterized by persistent excess volatility in returns to capital. We explore a quantitative case for theselearning equilibria. We use an evolutionary search algorithm to calibrate a version of the system under learning and show that this system can generate data that matches some features of the time-series data for U.S. stock returns and per-capita consumption. We argue that this finding provides support for the hypothesis that the observed excess volatility of asset returns can be explained by changes in investor expectations against a background of relatively small changes in fundamental factors.
    Review of Economic Studies 01/1984; 51(3):393-414. · 2.81 Impact Factor

Full-text

View
4 Downloads
Available from