The Impact of Risk Cycles on Business Cycles: A Historical View

40 Pages Posted: 16 Oct 2020

See all articles by Jon Danielsson

Jon Danielsson

London School of Economics - Systemic Risk Centre

Marcela Valenzuela

Pontificia Universidad Católica de Chile

Ilknur Zer

Board of Governors of the Federal Reserve System

Date Written: October 2020

Abstract

We investigate the effects of risk cycles on business cycles, using a panel spanning 150 years and 74 countries. We capture risk cycles by identifying periods when agents’ perception of financial risk is high and low. A long- lasting low-risk environment encourages risky investments that ultimately augment growth but at the cost of building up of vulnerabilities in the economy and thus, has a boom-to-bust effect on growth: an initial increase followed by a reversal in two years. Such an effect is particularly stronger for countries with excessive credit growth. Global risk cycles have a more pronounced effect on growth than local risk cycles, highlighting the relative importance of the global environment. Low-risk affects growth amid its notable impact on capital flows, investment, and lending quality.

Keywords: Stock market volatility, uncertainty, Minsky’s hypothesis, financial instability, risk-taking, granular instruments (GIV), global financial cycles

JEL Classification: F30, F44, G15, G18, N10, N20

Suggested Citation

Danielsson, Jon and Valenzuela, Marcela and Zer, Ilknur, The Impact of Risk Cycles on Business Cycles: A Historical View (October 2020). Available at SSRN: https://ssrn.com/abstract=3706143 or http://dx.doi.org/10.2139/ssrn.3706143

Jon Danielsson

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 (Contact Author)

Pontificia Universidad Católica de Chile ( email )

Vicuña Mackenna 4860
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

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