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A reconsideration of Minsky’s financial instabilityhypothesis

Bhattacharya, Sudipto, Goodhart, Charles, Tsomocos, Dimitrios P. and Vardoulakis, Alexandros P. (2015) A reconsideration of Minsky’s financial instabilityhypothesis. Journal of Money, Credit and Banking, 47 (5). pp. 931-973. ISSN 0022-2879

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Identification Number: 10.1111/jmcb.12229

Abstract

The worst and longest depressions have tended to occur after periods of prolonged, and reasonably stable, prosperity. This results in part from agents rationally updating their expectations during good times and hence becoming more optimistic about future economic prospects. Investors then increase their leverage and shift their portfolios towards projects that would previously have been considered too risky. So, when a downturn does eventually occur, the financial crisis, and the extent of default, become more severe. Whereas a general appreciation of this syndrome dates back to Minsky [1992, Jerome Levy Economics Institute, WP 74] and even beyond, to Irving Fisher [1933, Econometrica 1, 337-357], we model it formally. In addition, endogenous default introduces a pecuniary externality, since investors do not factor in the impact of their decision to take risk and default on the borrowing cost. We explore the relative advantages of alternative regulations in reducing financial fragility, and suggest a novel criterion for improvement of aggregate welfare.

Item Type: Article
Official URL: http://onlinelibrary.wiley.com/journal/10.1111/(IS...
Additional Information: © 2015 The Ohio State University
Divisions: Financial Markets Group
Subjects: H Social Sciences > HG Finance
JEL classification: D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D81 - Criteria for Decision-Making under Risk and Uncertainty
D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D83 - Search; Learning; Information and Knowledge; Communication; Belief
E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E44 - Financial Markets and the Macroeconomy
G - Financial Economics > G0 - General
G - Financial Economics > G2 - Financial Institutions and Services > G21 - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
Sets: Research centres and groups > Financial Markets Group (FMG)
Date Deposited: 29 Oct 2015 12:19
Last Modified: 20 Mar 2019 02:44
URI: http://eprints.lse.ac.uk/id/eprint/64218

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