We propose an amplification mechanism of financial crises based on the information
choice of investors. Information acquisition always makes investors more likely to act
against what is suggested by the prior. Deteriorating public news under an initially
strong (weak) prior increases (reduces) the value of private information and induces
more (less) information acquisition. Deteriorating public news always increases the
probability of a crisis, since the initially strong (weak) prior suggests do-not-attack (attack).
This effect is amplified when information choices are endogenous. To enhance
financial stability, a policymaker can use taxes and subsidies to affect information acquisition.
We also derive testable implications for the magnitude of amplification.
complementarities amplification financial crises global games information choice