Abstract

http://ssrn.com/abstract=1697815
 
 

References (12)



 
 

Citations (1)



 


 



Greenspan's Retrospective of Financial Crisis and Stochastic Optimal Control


Jerome L. Stein


Brown University - Division of Applied Mathematics; CESifo (Center for Economic Studies and Ifo Institute)


European Financial Management, Vol. 16, No. 5, pp. 858-871, November 2010

Abstract:     
Alan Greenspan argues that the crisis was unpredictable and inevitable, given the ‘excessive’ leverage of the financial intermediaries. I focus upon the housing sector, which has been at the origin of the financial crisis because the value of the financial derivatives ultimately depended upon the ability of the mortgagors to repay their debts. The uncertainty concerns the capital gains – housing price appreciation – and the rate of interest. I explain why the application of stochastic optimal control (SOC) is an effective approach to determine the optimal degree of leverage, the optimum and excessive risk and the probability of a debt crisis. I show that the theoretically derived early warning signal of a crisis is the excess debt ratio, equal to the difference between the actual and optimal ratio. The excess debt of households starting from 2004-05 indicated that a housing crisis was most likely.

Number of Pages in PDF File: 14

Accepted Paper Series


Date posted: October 26, 2010  

Suggested Citation

Stein, Jerome L., Greenspan's Retrospective of Financial Crisis and Stochastic Optimal Control. European Financial Management, Vol. 16, No. 5, pp. 858-871, November 2010. Available at SSRN: http://ssrn.com/abstract=1697815 or http://dx.doi.org/10.1111/j.1468-036X.2010.00579.x

Contact Information

Jerome L. Stein (Contact Author)
Brown University - Division of Applied Mathematics ( email )
Providence, RI 02912
United States
401-863-2143 (Phone)
401-863-1355 (Fax)
CESifo (Center for Economic Studies and Ifo Institute)
Poschinger Str. 5
Munich, DE-81679
Germany
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References:  12
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