Follow the Money: The Monetary Roots of Bubbles and Crashes

32 Pages Posted: 29 Nov 2011

See all articles by Fulvio Corsi

Fulvio Corsi

University of Pisa - Department of Economics; City University London

Didier Sornette

ETH Zürich - Department of Management, Technology, and Economics (D-MTEC); Swiss Finance Institute; Southern University of Science and Technology; Tokyo Institute of Technology

Date Written: November 21, 2011


We propose a reduced form model for the Minskian dynamics of liquidity and of asset prices in terms of the so-called financial accelerator mechanism. In a nutshell, credit creation is driven by the market value of the financial assets employed as collateral in the bank loans. This leads to a self-reinforcing feedback between financial prices and liquidity that we model by coupled non-linear stochastic processes. We show that the resulting dynamics are characterized by a transient super-exponential growth qualifying a bubble regime. Unchecked, this would lead to a finite time singularity (FTS). The underlying singularity expresses the unsustainable dynamics of the corresponding economy and announces a regime change, such as a crash. We propose to describe the dynamics of the crisis by the same coupled non-linear stochastic process with inverted signs, i.e., non-linear negative feedback of value and money on their growth rates. Casting the financial accelerator dynamics into a simple macroeconomic model, we show that the cycle of booms and bursts of financial assets and liquidity determines economic recessions in the form of increasing aggregate default rates and decreasing GDP. Finally, by exploiting the implications of the proposed model on the dynamics of financial asset returns, we introduce a generalized GARCH process, called FTS-GARCH, that can provide an early warning identification of bubbles. Estimating the FTS-GARCH on well-known historical bubble episodes suggest the possibility to diagnose in real-time the presence of bubbles in financial time series.

Keywords: Minskian dynamics, financial bubbles, positive feedback, financial accelerator, generalized FTS-GARCH

JEL Classification: G01, G17, C53

Suggested Citation

Corsi, Fulvio and Sornette, Didier, Follow the Money: The Monetary Roots of Bubbles and Crashes (November 21, 2011). Swiss Finance Institute Research Paper No. 11-60, Available at SSRN: or

Fulvio Corsi

University of Pisa - Department of Economics ( email )

via Ridolfi 10
I-56100 Pisa, PI 56100


City University London ( email )

Northampton Square
London, EC1V OHB
United Kingdom

Didier Sornette (Contact Author)

ETH Zürich - Department of Management, Technology, and Economics (D-MTEC) ( email )

Scheuchzerstrasse 7
Zurich, ZURICH CH-8092
41446328917 (Phone)
41446321914 (Fax)


Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4

Southern University of Science and Technology

1088 Xueyuan Avenue
Shenzhen, Guangdong 518055

Tokyo Institute of Technology

2-12-1 O-okayama, Meguro-ku
Tokyo 152-8550, 52-8552

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