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Asymmetric Price Movements and Borrowing Constraints: A Rational Expectations Equilibrium Model of Crises, Contagion, and Confusion



    1. 1University of Michigan
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    • Yuan is from University of Michigan. This paper is based on my dissertation at the Massachusetts Institute of Technology. I thank my advisors Paul Krugman, Jeremy Stein, and Jiang Wang, as well as Dimitri Vayanos, Mark Aguiar, Kobi Braude, Maciej K. Dudek, Denis Gromb, Guido Lorenzoni, Stewart C. Meyers, Markus M. Möbius, Whitney Newey, Emre Ozdenoren, Steve Ross, and Jay Yuan; an anonymous referee; the editor, Rick Green; and seminar participants at Arizona State University, Baruch College, Harvard, Massachusetts Institute of Technology, University of Chicago, University of Maryland, University of Michigan, and University of Utah, for helpful comments. Any errors are mine.


This study proposes a rational expectations equilibrium model of crises and contagion in an economy with information asymmetry and borrowing constraints. Consistent with empirical observations, the model finds: (1) Crises can be caused by small shocks to fundamentals; (2) market return distributions are asymmetric; and (3) correlations among asset returns tend to increase during crashes. The model also predicts: (1) Crises and contagion are likely to occur after small shocks in the intermediate price region; (2) the skewness of asset price distributions increases with information asymmetry and borrowing constraints; and (3) crises can spread through investor borrowing constraints.