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Catastrophe theory and the financial crisis
Author(s) -
Wesselbaum Dennis
Publication year - 2017
Publication title -
scottish journal of political economy
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.4
H-Index - 46
eISSN - 1467-9485
pISSN - 0036-9292
DOI - 10.1111/sjpe.12133
Subject(s) - financial crisis , economics , catastrophe theory , systemic risk , state (computer science) , financial system , actuarial science , macroeconomics , engineering , geotechnical engineering , algorithm , computer science
This paper develops and estimates catastrophe‐augmented models of the financial crisis. We employ catastrophe theory to explain discontinuous jumps in state variables of dynamic systems. We estimate an augmented bank failure model showing that the buildup of risk and an increase in the Federal Funds rate combined with low reserves (negative insurance effect) have been the main drivers of the financial crisis. Therefore, macroprudential policy and rating agencies play a key role in preventing the buildup of (systemic) risk and preventing the economy from entering a bifurcation area.