Contingent claim analysis and Minsky’s financial instability hypothesis

The idea of interrelated balance sheets is an integral part of modern Post-Keynesian Stock-Flow Consistent modeling which emphasizes the interaction between the financial and the real side of the economy. However, the same idea is used in the growing literature on Contingent Claim Analysis as a novel tool that can be used by regulatory authorities in their evaluation of risk assumed by financial institutions. This paper combines these approaches with Minsky’s Financial Instability Hypothesis and its focus on financial fragility with respect to the dynamics of the financial structure of economic units through the cycle. The main contribution of our paper is to show that Contingent Claims Analysis within a Minskyan framework might become a powerful regulatory tool and a valuable addition to Post-Keynesian Stock-Flow Consistent modeling since, through its provision for non-linearities and market volatility, it provides a realistic forward-looking depiction of the interplay between the real and financial side of the economy.