Abstract
We analyze a tractable rational expectations equilibrium model with margin constraints. We argue that constraints affect and are affected by informational efficiency, leading to a novel amplification mechanism. A decline in wealth tightens constraints and reduces investors’ incentive to acquire information, lowering price informativeness. Lower informativeness, in turn, increases the risk borne by financiers who fund trades, leading them to further tighten constraints faced by investors. This information spiral leads to (a) significant increases in risk premium and return volatility in crises, when investors wealth declines, (b) complementarities in information acquisition in crises, and (c) complementarities in margin requirements.
A Large-Market Rational Expectations Equilibrium Model