The Information Driven Financial Accelerator

Imperfect information in credit markets is a quantitatively important source of macroeconomic fragility. We calibrate a dynamic model with uninformed debt investors. A deterioration in the profit outlook makes investors pessimistic about firm creditworthiness. In turn, firms perceive that debt is underpriced and cut back investment. We show that: 1) the model matches the size and cyclical variation of credit spreads; 2) imperfect information accounts for about half of the spike in spreads and one-fifth of the contraction in aggregate investment during the US financial crisis; 3) the economic costs of imperfect information for firm value and investment are substantial.