Assessment of Whether Financial Crises Can Be Reliably Predicted Name of University: Student Name
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Running head: ASSESSMENT OF WHETHER FINANCIAL CRISES CAN BE RELIABLYPREDICTEDAssessment of Whether Financial Crises Can be Reliably PredictedName of Student:Name of University:Author’s Note:
ASSESSMENT OF WHETHER FINANCIAL CRISES CAN BE RELIABLY PREDICTED1AbstractThe study aims to find whether the early warning signs of financial crisis can be reliablymeasured. It has discussed rationale such as macroeconomic variants for being the main factorfor causing financial crisis with the use of several secondary sources of research topic. The studyhas been further able to explore the broad types of the “financial and macroeconomic variables”and consider “general-to-specific model selection process” for evaluating the most consistentpredictors of financial crises across 14 developed countries. The total time considered for theanalysis was taken from the trend of more than 100 years. The “in-sample findings have beenable to show that the income inequality is having the predictive power beyond loan growth andseveral other financial variables”. In addition to this, the out-sample forecasts made in theprevious studies are seen with “predictive power” which inclines to “vary considerably overtime”. However, the income equality is having predictive power for each of the “forecastingperiod”. Other inferences made from the previous studies on financial crisis brought by thecurrent account imbalances has been able to signify that in most of cases the variables set for theresearch neglects the early warning predictors despite of the prominence in the theory and thecase studies associated to the crisis. In addition to this, factors such as credit boom have beenheld responsible for aftermath of the crisis, however they cannot be considered as the onlyreason. The factors leading to financial crises can be ranging from several factors which includes“private banknotes (during the Panic of 1819) to the runs on repo, commercial paper, and primerbroker balances during the crisis of 2007-2009”.
ASSESSMENT OF WHETHER FINANCIAL CRISES CAN BE RELIABLY PREDICTED2Table of ContentsChapter 1..........................................................................................................................................5Introduction to the topic...................................................................................................................51.1Introduction............................................................................................................................51.2 Background of the Study.......................................................................................................51.3 Research Purpose...................................................................................................................71.4 Research Objectives...............................................................................................................71.5 Research Questions................................................................................................................81.6 Structure of the Dissertation..................................................................................................8Chapter 2..........................................................................................................................................8Literature Review............................................................................................................................82.1 Aggregate Expenditure..........................................................................................................82.2 Boom and Bust cycle.............................................................................................................92.3 Current account imbalances.................................................................................................102.4 Income Inequality................................................................................................................112.5 Budgetary Crisis..................................................................................................................122.6 Deposit system.....................................................................................................................122.7 Global imbalances...............................................................................................................13Chapter 3........................................................................................................................................14Methodology..................................................................................................................................143.1 Introduction to the data collection.......................................................................................143.2 Data Sampling Method........................................................................................................153.3 Research Approach..............................................................................................................15
ASSESSMENT OF WHETHER FINANCIAL CRISES CAN BE RELIABLY PREDICTED33.4 Data collection Method........................................................................................................153.5 Dependent and Independent Variables................................................................................173.6 Data Analysis Method.........................................................................................................18Chapter 4........................................................................................................................................224.1 Finding/Results....................................................................................................................224.3 Subsample Predictions.........................................................................................................254.4 Out of Sample Forecasting Performance: 1980-2008.........................................................284.5 Predictions made with income inequality............................................................................294.6 Aggregate expenditure impact on financial crisis...............................................................314.7 Prediction of financial crisis with current account imbalance.............................................324.8 Global imbalance impact on financial crisis........................................................................324.9 Deposit insurance impact in predicting financial crisis.......................................................33Chapter 5........................................................................................................................................34Conclusion.....................................................................................................................................34List of Appendices.........................................................................................................................36List of References..........................................................................................................................44
ASSESSMENT OF WHETHER FINANCIAL CRISES CAN BE RELIABLY PREDICTED4List of FiguresFigure 1: Global Income inequality within country and between country....................................29Figure 2: Country wise risk of income inequality.........................................................................30List of TablesChapter 1 Introduction to the topic1.1IntroductionIn modern economics financial crisis is seen as a recurring phenomenon. The crisis of“2007-2009” was a stark recall of the “financial crashes” which shook the world by surprise. Thevarious types of the cause of the academic interest in the financial crises is considered with thehistorical events. The discourse of the study aims to find whether early warnings of the financialcrises may be identified. The investigation of the research will rely on the previous work of theeconomists and policy makers in recognition of the crises. Additionally, the early warningindicators of the financial crisis is observed with the work of these “economists” and the policymakers with the prevention and development of the crises. Despite of the several theories, therehas been no “consensus on whether the macroeconomic or the financial factors” has a significantrole in the prediction of the financial crises (Wang and Hua 2014).In general, inequality in the income is identified with the increasing attention of the“economic research in including the economic growth, political economy, schooling and savingof the behaviour”. The concept of income equality was depicted with an augmented emphasisbefore the crisis of “2007-2009 (as it was before the Great Depression)”. This concern hasremained constant in the developed economies. As stated by Lee, Sameen and Cowling (2015),the potential role of driving the financial crisis has remained doubtful. Some of the other paperson the income equality is further able to focus on the increase in the inequality and theprobability of the financial crises or impacts of credit booms. In other empirical research the
ASSESSMENT OF WHETHER FINANCIAL CRISES CAN BE RELIABLY PREDICTED5income equality is assessed to be consistent with the ingredient in growth for the bank loans orthe developmental activities during the financial crisis (Almamy, Aston and Ngwa 2016).1.2 Background of the StudyIn terms of the financial aspect, credit boom was identified as the key contributor for the“financial crises in developed countries over the last 140 years”. A more recent study hasfocused on the mortgage lending for the households, which has increased to a significant level inthe last century. The linking of the abnormal credit growth is recognised between 1970 and 2007.However, in this period the linkages in the abnormal credit growth is observed in only out of thethree financial crises. Henceforth, credit boom by themselves are considered as an insufficientprerequisite for the financial crises. The study has been able to take a further step inunderstanding the relative role for the financial predictors and real roles driving the financialcrises. The evaluation of the probability of the financial predictors is seen to be considered withthe predictive “power of a broad set of potential” macroeconomic and financial factors over thenext 100 years. Instead of imposing a strong priori restriction on the empirical model, the mainemphasis is employed with general to specific model selection. This seen with the determinationof the predictive relative factors. The research study is able to employ a “general to specificmodel selection process” for the determination of the appropriate predictors and the existing lags(Adebambo, Brockman and Yan 2015).The inclusion of the income “inequality and credit booms” along with other relevanteconomic factors are able to clarify the occurrence of the “financial crises” included with thecollapses of “asset bubbles, deregulation, financial innovations, movements of real interest rates,deposit insurance schemes, growth of the monetary base, and current account”. The researchstudy is also able to evaluate the potential interactions among the real and the financial factorswhich are seen to be evident with case of income inequality. Empirical research has provided acompelling evidence on the income equality with the primary drivers and the upsurge in the“household debt” in the “United States during 1980s and 1990s” (Doogar, Rowe and Sivadasan2015). Some of the other empirical evidences is further able to show that inequality may increasethe leverage among the middle-income and poor households due to the consumption smoothingbrought by borrowing against future incomes. The connection of these studies with the relevantfindings has stated on the credit boom literature implied with income equality which may be a
ASSESSMENT OF WHETHER FINANCIAL CRISES CAN BE RELIABLY PREDICTED6result of the actual real “side cause of risk of financial instability”. This risk is directlyattributable to the credit bubbles. In arguing of the rising nature of the inequality led byredeployment in the form of “subsidized housing finance” housing boom and subsequent crashesare taken into consideration for the discussion (Ahrend and Goujard 2014). The important considerations of the paper are able to include the dataset of 14 developedcountries over 1870-2008, which is provided by other empirical research by “KarolinKirschenmann Department of Finance, Aalto University School of Business”. This study waspublished in April 29, 2015. The main research will be based on secondary sources along withqualitative analysis in terms of the depictions made in this research paper for the assessment offinancial crisis. The differentiating aspect of the study has included the work in two significantbehaviours. Firstly, the “predictive power needs to be” distributed among larger set of variables”and examining these potential predictors and lags in the joint model. Secondly, the study hasemployed a methodology for flexible and “general to specific model selection” between thevarious predictors “without imposing restrictive assumptions on the channels through which,income inequality impacts the risk of financial crises” (Persakis and Iatridis 2016).1.3 Research PurposeThe main purpose of the paper has considered the “long-time series” which has exploitedto achieve the relation of the long-time series for determining the roles in different crisessituations. The “long-time series” format is important for accomplishment of the out-of-sampleforecasts. The main considerations for the long-term costs have gained the importance since1980. During this time when financial liberalization began, the data indicators were based on theconsideration of deregulation and availability of the comparative short time periods. The paperhas also examined the robustness check between 1962-2008 which was available from the dataon the size of the U.S. joint fund industry. This is identified as a major indicator of the factorsleading of the financial innovation and deregulation which are available for shorter time periods.The discourse of the study has examined the in-sample robustness “checked for the 1962-2008 period”. The availability of the “data on the size of the US mutual fund industry” isconsidered as an indicator for the investment for the “innovative and riskier investment classes”.
ASSESSMENT OF WHETHER FINANCIAL CRISES CAN BE RELIABLY PREDICTED7The results have been able to confirm the entire sample findings. Moreover, the results havedepicted that a larger U.S. mutual fund industry has been depicted with a higher financial riskprior to the financial crisis.1.4 Research ObjectivesThe main objectives set for the research are enumerated below as follows:Contribution of macroeconomic factor such as income equality in financial crisisStudying the role of aggregate expenditure in terms of financial crisisRole of economic expansion during boom and bust cycles in predicting the financialcrisisGlobal Imbalances contribution to financial crisisImpact of Budgetary crisis on financial crisis1.5 Research QuestionsThe research questions formulated for the study are listed below as follows:1.What is the role of income equality in determining financial crisis?2.How is aggregate expenditure able to signal early signs of economic downturn in acountry?3.What predictions of financial crisis are suggested with “boom and bust cycles”?4.What is the impact of “current account imbalances in determining” financial crisis?5.How well the changes in the deposit system and global imbalances able to predictfinancial crisis?6.What is the role of budgetary crisis in determining financial crisis?1.6 Structure of the DissertationThe study is segregated into five chapters. The first chapter is able to introduce to thetopic along with the research objectives, purpose, background and research questions. Thesecond chapter has organized the associated literature and the way it is able to motivate thepredictor variables in the data. The third section has outlined the methodology for conducting theresearch and the fourth section has presented the results. The fifth section has concluded thepaper.
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