The Impact of Risk Cycles on Business Cycles: A Historical View
Download paperDanielsson, J., M. Valenzuela, and I. Zer (2023). The impact of risk cycles on business cycles: A historical view. Review of Financial Studies.
We investigate the effects of financial risk cycles on business cycles, using a panel spanning 73 countries since 1900. Agents use a Bayesian learning model to form their beliefs on risk. We construct a proxy of these beliefs and show that perceived low risk encourages risk-taking, augmenting growth at the cost of accumulating financial vulnerabilities, and therefore, a reversal in growth follows. The reversal is particularly pronounced when the low-risk environment persists and credit growth is excessive. Global-risk cycles have a stronger effect on growth than local-risk cycles via their impact on capital flows, investment, and debt-issuer quality.
@article{DanielssonValenzuelaZer2020, title={The Impact of Risk Cycles on Business Cycles: A Historical View}, author={J{\'o}n Dan{\'i}elsson and Marcela Valenzuela and Ilknur Zer}, journal={Review of Financial Studies}, year=2023, abstract={We investigate the effects of financial risk cycles on business cycles, using a panel spanning 73 countries since 1900. Agents use a Bayesian learning model to form their beliefs on risk. We construct a proxy of these beliefs and show that perceived low risk encourages risk-taking, augmenting growth at the cost of accumulating financial vulnerabilities, and therefore, a reversal in growth follows. The reversal is particularly pronounced when the low-risk environment persists and credit growth is excessive. Global-risk cycles have a stronger effect on growth than local-risk cycles via their impact on capital flows, investment, and debt-issuer quality. }, url={https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4227577} }
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