The Information View of Financial Crises

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 inf...

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Bibliographic Details
Published in:Annual review of financial economics 2020-11, Vol.12 (1), p.39-65
Main Authors: Dang, Tri Vi, Gorton, Gary, Holmström, Bengt
Format: Article
Language:English
Subjects:
financial crises
information insensitivity
JEL E32
JEL E51
safe debt
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Summary: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.
ISSN:1941-1367
1941-1375
DOI:10.1146/annurev-financial-110118-123041