Jon Danielsson, Marcela Valenzuela, Ilknur Zer — Volatility, financial crises and Minsky's hypothesis

Does low volatility in financial markets mean that another financial crisis is more likely? And should we be worried when everything is OK? This column presents the first empirical results that find a strong validation of Minsky's hypothesis – obtained from 200 years of historical cross-sectional data – that low volatility increases the likelihood of future financial crisis by increasing risk-taking.

Perhaps the most significant thing about this study is that people are starting to look at Hyman Minsky and take him seriously.

While the common view maintains that volatility directly affects the probability of a crisis, this has been proven difficult to verify empirically.

In what we believe is the first study to do so, we find direct empirical evidence that the level of volatility is not a good indicator of crisis, but that unexpectedly high and low volatilities are.

This is directly in line with what is predicted by theory and provides a validation of Minsky's hypothesis – stability is destabilising.

Market volatility is of clear interest to policymakers, with the quote of chairwoman Yellen above just one example.

By documenting how volatility can affect the risk-taking behavior of economic agents and hence, the incidence of financial crises, policymakers and market participants alike would gain a valuable tool in understanding crises, tail events and systemic risk.

VOXEU
Volatility, financial crises and Minsky's hypothesis
Jon Danielsson, Marcela Valenzuela, Ilknur Zer