IDEAS home Printed from https://ideas.repec.org/p/bon/boncrc/crctr224_2023_431v2.html
   My bibliography  Save this paper

Evaluating the Financial Instability Hypothesis: A Positive and Normative Analysis of Leveraged Risk-Taking and Extrapolative Expectations

Author

Listed:
  • Antoine Camous
  • Alejandro Van der Ghote

Abstract

Classical accounts of financial crises emphasize the joint contribution of extrapolative beliefs and leveraged risk-taking to financial instability. This paper proposes a simple macro-finance framework to evaluate these views. We find a novel interplay between non-rational extrapolation and investment risk-taking that amplifies financial instability relative to a rational expectation benchmark. Furthermore, the analysis provides guidance on the design of cyclical policy intervention. Specifically, extrapolative expectations command tighter financial regulation, irrespective of the regulator's degree of non-rational extrapolation.

Suggested Citation

  • Antoine Camous & Alejandro Van der Ghote, 2023. "Evaluating the Financial Instability Hypothesis: A Positive and Normative Analysis of Leveraged Risk-Taking and Extrapolative Expectations," CRC TR 224 Discussion Paper Series crctr224_2023_431v2, University of Bonn and University of Mannheim, Germany, revised May 2024.
    • Handle: RePEc:bon:boncrc:crctr224_2023_431v2
    as

    Download full text from publisher

    File URL: https://www.crctr224.de/research/discussion-papers/archive/dp431
    Download Restriction: no
    ---><---

    More about this item

    Keywords

    financial frictions; financial amplifications; diagnostic expectations; financial regulation;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General
    • E70 - Macroeconomics and Monetary Economics - - Macro-Based Behavioral Economics - - - General
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • G40 - Financial Economics - - Behavioral Finance - - - General

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:bon:boncrc:crctr224_2023_431v2. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no bibliographic references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: CRC Office (email available below). General contact details of provider: https://www.crctr224.de .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.