We propose an amplification mechanism of financial crises based on the information choices of investors. Information acquisition makes investors more likely to act against their prior. Deteriorating public news under an initially strong (weak) prior increases (reduces) the value of private information and induces more (less) information acquisition. Deteriorating public news increases the probability of a crisis, since the initially strong (weak) prior induces no attacks (attacks). This effect is amplified with endogenous information choices. To enhance financial stability, a policy maker affects information acquisition via taxes and subsidies. We derive and discuss testable implications for the magnitude of amplification.

We examine the portfolio choice of banks in a micro-founded model of runs. To insure risk-averse investors against liquidity risk, competitive banks offer demand deposits. We use global games to link the probability of a run to the bank's portfolio management. Based upon interim information about risky investment, banks liquidate investments to hold a safe asset. This partial hedge against investment risk reduces the withdrawal incentives of investors for a given deposit rate. As a result, (i) banks provide more liquidity ex ante (so banks offer a higher deposit rate) and (ii) the welfare of investors increases. Our results highlight the management of both sides of a bank's balance sheet and a complementarity in the two forms of insurance that banks provide to investors.

We offer a theory of financial contagion based on the information choice of investors after observing a financial crisis elsewhere. We study global coordination games of regime change in two regions linked by an initially unobserved macro shock. A crisis in region 1 is a wake-up call to investors in region 2. It induces them to reassess the regional fundamental and acquire information about the macro shock. Contagion can occur even after investors learn that region 2 has no ex post exposure to region 1. We explore normative and testable implications of the model. In particular, our results rationalize evidence about contagious currency crises and bank runs after wake-up calls and provide some guidance for future empirical work.

We examine the effect of ex-post information contagion on the ex-ante level of systemic risk defined as the probability of joint bank default. Because of counterparty risk or common exposures, bad news about one bank reveals valuable information about another bank, triggering information contagion. When banks are subject to common exposures, information contagion induces small adjustments to bank portfolios and therefore increases overall systemic risk. When banks are subject to counterparty risk, by contrast, information contagion induces a large shift toward more prudential portfolios, thereby reducing systemic risk.

We present a screening model of the risk sensitivity of bank capital regulation. A banker funds a project with uninsured deposits and costly capital. Capital resolves a moral hazard problem in the choice of the probability of default (PD). The project’s loss given default (LGD) is the banker’s private information. The regulator receives a noisy signal about the LGD and imposes a minimum capital requirement. We show that the optimal sensitivity of capital regulation is non-monotonic in the accuracy of risk assessment. If the signal is inaccurate, the regulator should use risk-insensitive capital requirements. Given sufficient accuracy, the regulator should separate types via risk-sensitive capital requirements, reducing the risk-sensitivity of bank capital as accuracy improves.

We propose an amplification mechanism of financial crises based on the information choices of investors. Information acquisition makes investors more likely to act against their prior. Deteriorating public news under an initially strong (weak) prior increases (reduces) the value of private information and induces more (less) information acquisition. Deteriorating public news increases the probability of a crisis, since the initially strong (weak) prior induces no attacks (attacks). This effect is amplified with endogenous information choices. To enhance financial stability, a policy maker affects information acquisition via taxes and subsidies. We derive and discuss testable implications for the magnitude of amplification. Received November 3, 2015; editorial decision July 22, 2016 by Editor Itay Goldstein.

We offer a model of financial intermediaries as safe-asset providers in an international context. Investors from countries exposed to expropriation risk seek to invest in safe-haven countries in order to satisfy a demand for safety. Intermediaries compete for such cheap funding by carving out safe claims, which requires demandable debt. While these safety-seeking inflows allow developed countries to lower their funding cost and expand investment, risk-intolerant investors achieve safety by withdrawing even under minimal residual risk. As a result, safety-seeking inflows into developed countries not only reallocate but also create risk. Early liquidation inefficiently diverts scarce resources from productive uses, so a domestic planner wishes to contain the scale of safety-seeking inflows. A macroprudential regulator imposes a Pigouvian tax on safety-seeking inflows.

We propose a model of lending, payments choice, and privacy in the digital economy. While digital payments enable merchants to sell goods online, they reveal information to their lender. Cash guarantees anonymity, but limits distribution to less efficient offline venues. In equilibrium, merchants trade off the efficiency gains from online distribution (with digital payments) and the informational rents from staying anonymous (with cash). While new technologies can reduce the privacy concerns associated with digital payments, they also redistribute surplus from the lender to merchants. Hence, privacy enhancements do not always improve welfare.

We use a new data set on macroprudential foreign exchange (FX) regulations to evaluate their effectiveness and unintended consequences. Our results support the predictions of a model in which banks and markets lend in different currencies, but only banks can screen firm productivity. Regulations significantly reduce bank FX borrowing, and firms respond by increasing FX debt issuance. Moreover, regulations reduce bank sensitivity to exchange rates but are less effective at reducing the sensitivity of the broader economy. Therefore, FX regulations mitigate bank vulnerability to currency fluctuations and the global financial cycle, but appear to partially shift the snowbanks of vulnerability elsewhere.

We model asset encumbrance by banks subject to rollover risk and study the consequences for fragility, funding costs, and prudential regulation. A bank’s privately optimal encumbrance choice balances the benefit of expanding profitable, yet illiquid, investment funded by cheap long-term senior secured debt, against the cost of greater fragility from runs on unsecured debt. We derive testable implications about encumbrance ratios. The introduction of deposit insurance or wholesale funding guarantees induces excessive encumbrance and fragility. Limits on asset encumbrance or Pigovian taxes eliminate such risk-shifting incentives. Our results shed light on prudential policies currently being pursued in several jurisdictions. Received September 9, 2017; editorial decision July 28, 2018 by Editor Philip Strahan.