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IESE Research Papers,
IESE Business School

No D/1064: Risk-Sharing and Crises. Global Games of Regime Change with Endogenous Wealth

Rolf Campos ()
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Rolf Campos: IESE Business School, Postal: IESE Business School. Research Division, Av Pearson 21, 08034 Barcelona, SPAIN

Abstract: I add heterogeneous agents and risk-sharing opportunities to a global game of regime change. The novel insight is that when there is a risk-sharing motive, fundamentals drive not only individual behavior, but also select which individuals are more relevant for the likelihood of a crisis because of endogenous shifts in wealth. If attacking is relatively safe, attack behavior in the global game and trade in state-contingent assets feed back into each other. This feedback implies that multiple equilibria may exist even if signal noise becomes arbitrarily small. In addition, heterogeneity in risk-aversion within the population amplifies the influence of the state of the economy on the probability of a crisis.

Keywords: global games; risk-aversion; heterogeneous agents; risk-sharing; financial crises; strategic risk

50 pages, January 30, 2013

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