Fed paper explores information problems in financial panics
Tight liquidity can cause investors’ beliefs to become “systematically divorced from fundamentals”
Information problems worsen during financial panics, generating further instability, research published by the Federal Reserve finds.
Levent Altinoglu and Jin-Wook Chang explore the role of asset prices in imperfectly conveying private information held by lenders and borrowers. They build a model in which investors’ beliefs about fundamental conditions are shaped endogenously by the availability of liquidity in funding and asset markets.
As liquidity declines (or becomes excessive), hints from
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