The Information View of Financial Crises

Posted: 10 Dec 2020

See all articles by Tri Vi Dang

Tri Vi Dang

Columbia University

Gary B. Gorton

Yale School of Management; National Bureau of Economic Research (NBER); Yale University - Yale Program on Financial Stability

Bengt R. Holmström

Massachusetts Institute of Technology (MIT) - Department of Economics; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

Date Written: November 2020

Abstract

Short-term debt that can serve as a medium of exchange is designed to be information insensitive. No one should be tempted to acquire private information to gain an informational advantage in trading that could destabilize the value of the debt. Short-term debt minimizes the incentive to acquire information among all securities of equal value backed by the same underlying asset. Moreover, backing short-term debt with debt (i.e., using debt as collateral) minimizes information sensitivity across all types of collateral with equal value. These features are consistent with financial crises occurring periodically. In the information view adopted here, a financial crisis can occur when the collateral backing the short-term debt is thought to have lost enough value to raise doubts among the traders that some may acquire private information. In a crisis, there is a shift from information-insensitive to information-sensitive debt.

Suggested Citation

Dang, Tri Vi and Gorton, Gary B. and Holmström, Bengt R., The Information View of Financial Crises (November 2020). Annual Review of Financial Economics, Vol. 12, pp. 39-65, 2020, Available at SSRN: https://ssrn.com/abstract=3744674 or http://dx.doi.org/10.1146/annurev-financial-110118-123041

Tri Vi Dang

Columbia University

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Gary B. Gorton

Yale School of Management ( email )

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Yale University - Yale Program on Financial Stability

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Bengt R. Holmström (Contact Author)

Massachusetts Institute of Technology (MIT) - Department of Economics ( email )

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