Fundamentals or Panic: Lessons from the Empirical Literature on Financial Crises
25 Pages Posted: 27 Oct 2010 Last revised: 7 Dec 2011
Date Written: October 26, 2010
There are two basic approaches to explaining financial crises. One argues that they are driven by bad fundamentals, while the other one argues that they reflect panic or coordination failures among investors. The empirical literature has established a fairly strong link between fundamentals and crises, suggesting support for the fundamental-based view and not for the panic-based view. However, in theory, the two approaches are not mutually exclusive: the link between fundamentals and crises does not go against the validity of the panic-based view. In fact, there are models that predict panic to be triggered by low fundamentals. The article reviews empirical evidence in the financial-crises literature in light of the tension between the fundamental-based and panic-based approach. It points out the limited ability to draw conclusions on the validity of the panic-based approach and describes possibilities for identifying panic in the data.
Keywords: Financial Crises, Panic, Fundamentals, Bank Runs, Currency Attacks, Contagion, Twin Crises, Global Games, Identification of Strategic Complementarities
Suggested Citation: Suggested Citation