Risk-Sharing and Crises: Global Games of Regime Change with Endogenous Wealth

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

JEL Classification: D8, G2, E3