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American Economic Review: Vol. 102 No. 7 (December 2012)

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Self-Fulfilling Risk Panics

Article Citation

Bacchetta, Philippe, Cédric Tille, and Eric van Wincoop. 2012. "Self-Fulfilling Risk Panics." American Economic Review, 102(7): 3674-3700.

DOI: 10.1257/aer.102.7.3674

Abstract

Recent crises have seen large spikes in asset price risk. We propose an explanation for such panics based on self-fulfilling shifts in beliefs about risk. A negative link between the current level and the future risk of an asset price leads to a circular relationship between the stochastic process of asset price risk and the price itself. Self-fulfilling shifts in perceived risk can be coordinated around a pure sunspot or around a macro fundamental. In a risk panic, a macro fundamental can be a focal point that affects both the magnitude of the panic and subsequent shifts in perceived risk.

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Authors

Bacchetta, Philippe (U Lausanne)
Tille, Cédric (Graduate Institute of International and Development Studies, Geneva)
van Wincoop, Eric (U VA)

JEL Classifications

D81: Criteria for Decision-Making under Risk and Uncertainty
E44: Financial Markets and the Macroeconomy
G01: Financial Crises
G12: Asset Pricing; Trading volume; Bond Interest Rates


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