We develop a multiple asset rational expectations model of asset prices to explain financial market contagion. Although the model allows contagion through several channels, our focus is on contagion through cross-market rebalancing. Through this channel, investors transmit idiosyncratic shocks...

This paper theoretically studies the effects of Knightian Uncertainty in interbank markets when the source of the Knightian Uncertainty is incomplete information on banks’ risk exposures. The main findings in the paper are: (1) When interbank loans are arranged in anonymous brokered, instead...

The bursting of the housing price bubble during 2007 and 2008 was accompanied by high interbank spreads, and a partial breakdown of interbank lending. This paper theoretically models how Knightian uncertainty over banks risk exposures may have contributed to the breakdown. The paper shows: 1)...