Staff Reports
Uncertain Booms and Fragility
Number 861
July 2018

JEL classification: D82, E02, G01

Authors: Michael Junho Lee

I develop a framework of the buildup and outbreak of financial crises in an asymmetric information setting. In equilibrium, two distinct economic states arise endogenously: “normal times,” periods of modest investment, and “booms,” periods of expansionary investment. Normal times occur when the intermediary sector realizes moderate investment opportunities. Booms occur when the intermediary sector realizes many investment opportunities, but also occur when it realizes very few opportunities. As a result, investors face greater uncertainty in booms. During a boom, subsequent arrival of negative information about an intermediary asset results in large downward shifts in investors’ confidence about the underlying quality of long-term assets. A crisis of confidence ensues. Investors collectively force costly early liquidation of the intermediated assets and move capital to safe assets, in a flight-to-quality episode.

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AUTHOR DISCLOSURE STATEMENT(S)
Michael Junho Lee
I declare that I have no relevant or material financial interests that relate to the research described in the paper titled “Uncertain Booms and Fragility.” Prior to circulation, this paper was reviewed in accordance with the Federal Reserve Bank of New York review policy, available at https://www.newyorkfed.org/research/staff_reports/index.html.