Jon Danielsson, Marcela Valenzuela, Ilknur Zer — Volatility, financial crises and Minsky's hypothesis

Does low volatility in financial markets mean that another financial crisis is more likely? And should we be worried when everything is OK? This column presents the first empirical results that find a strong validation of Minsky's hypothesis – obtained from 200 years of historical cross-sectional data – that low volatility increases the likelihood of future financial crisis by increasing risk-taking.

Perhaps the most significant thing about this study is that people are starting to look at Hyman Minsky and take him seriously.

While the common view maintains that volatility directly affects the probability of a crisis, this has been proven difficult to verify empirically.

In what we believe is the first study to do so, we find direct empirical evidence that the level of volatility is not a good indicator of crisis, but that unexpectedly high and low volatilities are.

This is directly in line with what is predicted by theory and provides a validation of Minsky's hypothesis – stability is destabilising.

Market volatility is of clear interest to policymakers, with the quote of chairwoman Yellen above just one example.

By documenting how volatility can affect the risk-taking behavior of economic agents and hence, the incidence of financial crises, policymakers and market participants alike would gain a valuable tool in understanding crises, tail events and systemic risk.

VOXEU
Volatility, financial crises and Minsky's hypothesis
Jon Danielsson, Marcela Valenzuela, Ilknur Zer

Sunanda Sen — Turbulence and Stability in Financial Markets: China in Recent Times

Liberalisation of financial markets, as observed in different parts of the world economy, has never contributed to stability—avoiding unforeseen and unbridled movements in prices and quantities—in those markets. Discontinuation of state-level restraints, in deregulated markets, always generates an atmosphere of uncertainty, which itself has been instrumental in generating turbulence, and then leading to crises. Crises in different financial markets across the world are usually preceded by booms, fed by destabilising financial activities in opened-up markets. 

The current downslide in China’s stock markets has followed this familiar pattern, with the crash that took place between June and July 2015 foreshowed by an unprecedented boom which came with the fast pace of liberalisation in the financial sector.

Capitalism isn't all it is cracked up to be because volatility. As China is learning the hard way.

Is there really no alternative, or is the world stuck with TINA, as Margaret Thatcher famously proclaimed?

Here comes the rather unique relation between the market and the state in China, with the latter in a position to reverse the opening-up process, especially with measures designed to regulate the market.

Interestingly enough, steps as above have been labelled as “contradictions of capitalist China” in the western press and as a “dangerous game of manipulating the stock market” by Larry Summers, the former U.S. Treasury Secretary.…

In judging the current situation, the West seems reluctant to accept the philosophy of the authoritarian Chinese state which, while recognising the role of the market under globalisation, has not given up the role of the state as in a command economy. The turmoil in China’s stock market, still requiring further regulatory measures by the state, remain both an enigma and a paradigm for those who continue to be blinded by the myth of efficiency and stability in free markets!

Of course, the US government including the central bank felt it necessary to intervene to stabilize markets at the time of financial crisis in the US, both at the time of the Great Depression and the 2008 meltdown that threatened not only the US but also the global economy. The assumption of spontaneous natural order and automatic self-correction went out the window.

Triple Crisis
Turbulence and Stability in Financial Markets: China in Recent Times
Sunanda Sen | former Professor of Economics at Jawaharlal Nehru University, New Delhi.

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