Learning from History: Volatility and Financial Crises
47 Pages Posted: 21 Nov 2016
Date Written: October 2017
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
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