Learning from History: Volatility and Financial Crises

Review of Financial Studies, Forthcoming

FEDS Working Paper No. 2016-093

47 Pages Posted: 21 Nov 2016  

Jon Danielsson

London School of Economics - Systemic Risk Centre

Marcela Valenzuela

University of Chile

Ilknur Zer

Board of Governors of the Federal Reserve System

Date Written: October 2017

Abstract

We study the effects of stock market volatility on risk-taking and financial crises by constructing a cross-country database spanning up to 211 years and 60 countries. Prolonged periods of low volatility have strong in-sample and out-of-sample predictive power over the incidence of banking crises and can be used as a reliable crisis indicator, whereas volatility itself does not predict crises. Low volatility leads to excessive credit build-ups and balance sheet leverage in the financial system, indicating that agents take more risk in periods of low risk, supporting the dictum that “stability is destabilizing."

Keywords: Stock market volatility, Financial crises predictability, Volatility paradox, Minsky hypothesis, Financial instability, Risk-taking

JEL Classification: F30, F44, G01, G10, G18, N10, N20

Suggested Citation

Danielsson, Jon and Valenzuela, Marcela and Zer, Ilknur, Learning from History: Volatility and Financial Crises (October 2017). Review of Financial Studies, Forthcoming; FEDS Working Paper No. 2016-093. Available at SSRN: https://ssrn.com/abstract=2872651 or http://dx.doi.org/10.17016/FEDS.2016.093

Jon Danielsson (Contact Author)

London School of Economics - Systemic Risk Centre ( email )

Houghton Street
London WC2A 2AE
United Kingdom
+44.207.955.6056 (Phone)

HOME PAGE: http://www.riskreasearch.org

Marcela Valenzuela

University of Chile ( email )

Pío Nono Nº1, Providencia
Santiago, R. Metropolitana 7520421
Chile

Ilknur Zer

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Register to save articles to
your library

Register

Paper statistics

Downloads
1,266
rank
13,430
Abstract Views
4,720
PlumX