DP16809 A Wake-Up Call Theory of Contagion
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.