Ambiguity shifts and the 2007–2008 financial crisis |
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Authors: | Nina Boyarchenko |
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Institution: | Federal Reserve Bank of New York, 33 Liberty Street, New York, NY 10045, United States |
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Abstract: | Faced with doubts about the quality of information and the quality of modeling techniques, ambiguity-averse agents assign higher probabilities to lower utility states, leading to higher CDS premia and lower equity prices. Using data on financial institutions, I find that the sudden increases in credit spreads during the recent crisis can be explained by changes in the amount of ambiguity faced by market participants and changes in how the total amount of ambiguity was distributed between ambiguity about information quality and ambiguity about model quality. |
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