nep-ban New Economics Papers
on Banking
Issue of 2016‒06‒04
twenty-two papers chosen by
Christian Calmès, Université du Québec en Outaouais

  1. A dynamic network model of the unsecured interbank lending market By Blasques, Francisco; Brauning, Falk; Lelyveld, Iman Van
  2. How large banks use CDS to manage risks: bank-firm-level evidence By Hasan, Iftekhar; Wu, Deming
  3. Modelling and Forecasting Mortgage Delinquency and Foreclosure in the UK. By Janine Aron; John Muellbauer
  4. Indicators used in setting the countercyclical capital buffer By Kalatie, Simo; Laakkonen, Helinä; Tölö, Eero
  5. Does bank competition reduce cost of credit? Cross-country evidence from Europe By Fungáčová, Zuzana; Shamshur, Anastasiya; Weill, Laurent
  6. The impact of credit supply shocks and a new FCI based on a FAVAR approach By Zsuzsanna Hosszú
  7. Did foreign banks “cut and run” or stay committed to Emerging Europe during the crises? By Bonin, John P.; Louie, Dana
  8. Impact of Dodd-Frank on Small Community Lenders By Brewer, Brady; Russell, Levi
  9. Are too-big-to-fail banks history in Europe? Evidence from overnight interbank loans By Tölö, Eero; Jokivuolle, Esa; Virén, Matti
  10. Quantitative Easing and Financial Stability By Woodford, Michael
  11. The Impact of Bankruptcy Reform on Insolvency Choice and Consumer Credit By Jason Allen; Kiana Basiri
  12. Banking reform, risk-taking, and earnings quality – Evidence from transition countries By Fang, Yiwei; Hasan, Iftekhar; Li, Lingxiang
  13. Fine-tuning the use of bail-in to promote a stronger EU financial system By Micossi, Stefano; Bruzzone, Ginevra; Cassella, Miriam
  14. Credit control instruments in a dual banking system: leverage control rate (LCR) – a proposal By Hasan, Zubair
  15. Mobile collateral versus immobile collateral By Gary Gorton; Tyler Muir
  16. The Collateral Trap By Frederic Boissay; Russell Cooper
  17. Bailouts, Moral Hazard and Banks' Home Bias for Sovereign Debt By G. Gaballo; A. Zetlin-Jones
  18. Curbing Shocks to Corporate Liquidity: The Role of Trade Credit By Niklas Amberg; Tor Jacobson; Erik von Schedvin; Robert Townsend
  19. Financial Trouble Across Generations:Evidence from the Universe of Personal Loans in Denmark By Claus Thustrup Kreiner; Søren Leth-Petersen,; Louise C. Willerslev-Olsen
  20. Taming the Basel leverage cycle By Christoph Aymanns; Fabio Caccioli; J. Doyne Farmer; Vincent W.C. Tan
  21. Removing Moral Hazard and Agency Costs in Banks: Beyond CoCo Bonds By Kenjiro Hori; Jorge Martin Ceron
  22. Learning, Expectations, and the Financial Instability Hypothesis By Martin Guzman; Peter Howitt

  1. By: Blasques, Francisco (Vrije Universiteit Amsterdam); Brauning, Falk (Federal Reserve Bank of Boston); Lelyveld, Iman Van (De Nederlandsche Bank)
    Abstract: The unsecured interbank lending market plays a crucial role in financing business activity, a fact underscored by the market's disruption following the Lehman Brothers failure in September 2007. This event, a defining moment in the global financial crisis, fostered greater uncertainty about counterparty risk, an adverse shock that severely curtailed credit supply, hampered monetary policy, and negatively impacted the real economy. To counteract the consequences of the crisis, central banks became the primary intermediaries for a large portion of the money market. However, a single main counterparty reduces the incentives for peer monitoring and the market discipline obtained from private information about counterparty credit risk. To assess the benefits gained from having a decentralized market, this paper builds and estimates a dynamic network model of interbank lending using transaction-level data. The analysis focuses on assessing the roles that credit-risk uncertainty and private information, gathered through peer monitoring and repeated interactions, play in shaping the network of bilateral lending relationships, interest rates, loan volumes, and the liquidity allocation among banks. The paper also analyzes how changes in the central bank's interest rate corridor affect the interbank market structure.
    Keywords: interbank liquidity; financial networks; credit-risk uncertainty; peer monitoring; monetary policy; trading relationships; indirect parameter estimation
    JEL: C33 C51 E52 G01 G21
    Date: 2016–04–01
  2. By: Hasan, Iftekhar; Wu, Deming
    Abstract: ​We test five hypotheses on whether banks use CDS to hedge corporate loans, provide credit enhancements, obtain regulatory capital relief, and exploit banking relationship and private information. Linking large banks’ CDS positions and syndicated lending on individual firms, we observe strong evidence for the credit enhancement and regulatory capital relief hypotheses, but mixed evidence for the hedging, banking relationship, and private information hypotheses. Banks buy and sell more CDS on their borrowers, but their net CDS positions and lending status are largely unrelated. We find no evidence of bank using CDS to exploit private information.
    Keywords: hedging, credit enhancement, regulatory capital relief, banking relationship, private information
    JEL: G14 G21 G23 G28 G32
    Date: 2016–04–29
  3. By: Janine Aron; John Muellbauer
    Abstract: Abstract: In the absence of micro-data in the public domain, new aggregate models for the UK’s mortgage repossessions and arrears are estimated using quarterly data over 1983-2014, motivated by a conceptual double trigger frame framework for foreclosures and payment delinquencies. An innovation to improve on the flawed but widespread use of loan-to-value measures, is to estimate difficult-to-observe variations in loan quality and access to refinancing, and shifts in lenders’ forbearance policy, by common latent variables in a system of equations for arrears and repossessions. We introduce, for the first time in the literature, a theory-justified estimate of the proportion of mortgages in negative equity as a key driver of aggregate repossessions and arrears. This is based on an average debt-equity ratio, corrected for regional deviations, and uses a functional form for the distribution of the debt-equity ratio checked on Irish micro-data from the Bank of Ireland, and Bank of England snapshots of negative equity. We systematically address serious measurement bias in the ‘months-in-arrears’ measures, neglected in previous UK studies. Highly significant effects on aggregate rates of repossessions and arrears are found for the aggregate debt-service ratio, the proportion of mortgages in negative equity and the unemployment rate. Economic forecast scenarios to 2020 highlight risks faced by the UK and its mortgage lenders, illustrating the usefulness of the approach for bank stress-testing. For macroeconomics, our model traces an important part of the financial accelerator: the feedback from the housing market to bad loans and hence banks’ ability to extend credit.
    Keywords: foreclosures, mortgage repossessions, mortgage payment delinquencies, mortgage arrears, credit risk stress testing, latent variables model.
    JEL: G21 G28 G17 R28 R21 C51 C53 E27
    Date: 2016–04–11
  4. By: Kalatie, Simo; Laakkonen, Helinä; Tölö, Eero
    Abstract: According to EU legislation, the national authorities should use the principle of 'guided discretion' in setting the countercyclical capital buffer (CCB), which increases banks' resilience against systemic risk associated with periods of excessive credit growth. This means that the decision should be based on signals from a pre-determined set of early warning indicators, but that there should also be room for discretion, as there is always uncertainty associated with the use of early warning indicators. The European Systemic Risk Board (ESRB) recommends that the authorities use the deviation of the credit-to-GDP ratio from its long term trend value (credit-to-GDP gap) as the primary indicator in setting the CCB. In addition, designated authorities should use in their decision making indicators that measure private sector credit developments and debt burden, overvaluation of property prices, external imbalances, mispricing of risk, and strength of bank balance sheets. Based on an empirical analysis of data on EU countries and a large assortment of potential indicators, we propose a set of suitable early warning indicators for each of these categories.
    Keywords: countercyclical capital buffer, macroprudential policy, early warning indicators
    JEL: G01 G28
    Date: 2015–03–16
  5. By: Fungáčová, Zuzana; Shamshur, Anastasiya; Weill, Laurent
    Abstract: Despite the extensive debate on the effects of bank competition, only a handful of single-country studies deal with the impact of bank competition on the cost of credit. We contribute to the literature by investigating the impact of bank competition on the cost of credit in a cross-country setting. Using a panel of firms from 20 European countries covering the period 2001–2011, we consider a broad set of measures of bank competition, including two structural measures (Herfindahl-Hirschman index and CR5), and two non-structural indicators (Lerner index and H-statistic). We find that bank competition increases the cost of credit and observe that the positive influence of bank competition is stronger for smaller companies. Our findings accord with the information hypothesis, whereby a lack of competition incentivizes banks to invest in soft information and conversely increased competition raises the cost of credit. This positive impact of bank competition is however influenced by the institutional and economic framework, as well as by the crisis.
    Keywords: bank competition, bank concentration, cost of credit
    JEL: G21 L11
    Date: 2016–03–30
  6. By: Zsuzsanna Hosszú (Magyar Nemzeti Bank, Central Bank of Hungary)
    Abstract: In this paper, relying on a time-varying parameters FAVAR model, two credit supply factors are calculated, the first of which is identified as willingness to lend, while the second as lending capacity. The impact of these two types of credit supply shocks on macroeconomic variables and their changes in time is examined. The two types of lending shocks affect the macro variables rather differently; a positive lending capacity shock in a banking system mostly owned by non-residents influences GDP through the decrease in country risk and the easing of monetary policy, while willingness to lend primarily increases lending activity. The two financial shocks also differ in terms of their evolution over time: the change in the impact of willingness to lend was driven by foreign currency lending and one-off events (e.g. the outbreak of the crisis), thus the deviations occur usually for short periods of time and they are of small degree between the various quarters. On the other hand, in the case of lending capacity, trending processes can be observed: before the crisis the situation of the banking system plays an increasing role in country risk, while after 2008 it appears that monetary policy paid increasing attention to financial stability. Finally, a new type of financial conditions index is quantified based on our estimates, which measures the impact of the banking system’s lending activity on GDP growth.
    Keywords: dynamic factor model, dual Kalman-filter, financial conditions index, credit supply shocks, time varying parameter VAR.
    JEL: C32 C38 C58 E17 G21
    Date: 2016
  7. By: Bonin, John P.; Louie, Dana
    Abstract: Our objective is to examine empirically the behavior of foreign banks regarding real loan growth during a financial crisis for a set of countries in which these banks dominate the banking sectors due primarily to having taken over large existing former state-owned banks. The eight countries are among the most developed in Emerging Europe, their banking sectors having been modernized by the beginning of the time period.We consider a data period that includes an initial credit boom (2004 – 2007) followed by the global financial crisis (2008 & 2009) and the onset of the Eurozone crisis (2010). Our main innovations with respect to the existing literature on banking during the financial crisis are to include explicit consideration of exchange rate dynamics and to separate foreign banks into two categories, namely, subsidiaries of the Big 6 European MNBs and all other foreign-controlled banks. Our results show that bank lending was impacted adversely by the crisis but that the two types of foreign banks behaved differently. The Big 6 banks remained committed to the region in that their lending behavior was not different from that of domestic banks corroborating the notion that these countries are a “second home market” for these banks. Contrariwise, the other foreign banks were primarily responsible for fueling the credit boom prior to the crisis but then “cut and ran” by decreasing their lending appreciably during the crisis. Our results also indicate different bank behavior in countries with flexible exchange rate regimes from those in the Eurozone. Hence, we conclude that both innovations matter in empirical work on bank behavior during a crisis in the region and may, by extension, be relevant to other small countries in which banking sectors are dominated by foreign financial institutions.
    Keywords: foreign bank lending, financial crisis, multinational banks, Emerging Europe
    JEL: P34 G01 G15
    Date: 2015–11–04
  8. By: Brewer, Brady; Russell, Levi
    Abstract: With the passing of the Dodd-Frank Act in 2010, 10,000 new regulatory restrictions under Title 12 have been imposed on banks. This increase in regulation represents a great burden on financial institutions as it restricts avenues of revenue and causes an increase in compliance costs. While much attention has been paid to the Dodd-Frank Act, no empirical evidence exists to show the impact it has had on financial institutions and their profitability. Even though the Dodd-Frank Act targeted larger financial institutions, small banks, being defined as a bank with less than $250 million in total assets, are still regulated. With small community banks being a large provider of agricultural credit for farmers, the agricultural credit market relies heavily on small community banks being able to provide lending services to keep farmers in operation. This study examines the impact on profitability of small community banks and how that affects the availability of credit for the agricultural industry.
    Keywords: Banking, Dodd-Frank, Regulation, Agricultural Finance, Political Economy,
    Date: 2016–05–25
  9. By: Tölö, Eero; Jokivuolle, Esa; Virén, Matti
    Abstract: We investigate how European banks’ overnight borrowing costs depend on bank size. We use the Eurosystem’s proprietary interbank daily loan data on euro-denominated transactions from 2008-2014. We find that large banks have had a clear borrowing cost advantage over small banks and that this premium increases progressively with the size of the bank. This result is robust with respect to subsamples, subperiods, time aggregation, and control variables such as Tier 1 capital ratio and rating. During episodes of financial stress, the size advantage becomes several times larger. However, we also find evidence that the new recovery and resolution framework for banks may have slightly reduced the borrowing cost advantage of larger banks in Europe.
    Keywords: overnight rates, too-big-to-fail, implicit government guarantee, borrowing costs
    JEL: G21 G22 G24 G28
    Date: 2015–12–14
  10. By: Woodford, Michael
    Abstract: This paper compares three alternative dimensions of central-bank policy --- conventional interest-rate policy, quantitative easing, and macroprudential policy --- showing in the context of a simple intertemporal general-equilibrium model why they are logically independent dimensions of policy, and how they jointly determine financial conditions, aggregate demand, and the severity of risks to financial stability. Quantitative easing policies increase financial stability risk less than either of the other two policies, relative to the magnitude of aggregate demand stimulus; and a combination of expansion of the cental bank's balance sheet with a suitable tightening of macroprudential policy can have a net expansionary effect on aggregate demand with no increased risk to financial stability. This suggests that quantitative easing policies may be useful as an approach to aggregate demand management not only when the zero lower bound precludes further use of conventional interest-rate policy, but also when it is not desirable to further reduce interest rates because of financial stability concerns.
    Keywords: macroprudential policy; money premium; zero lower bound
    JEL: E44 E52
    Date: 2016–05
  11. By: Jason Allen; Kiana Basiri
    Abstract: We examine the impact of the 2009 amendments to the Canadian Bankruptcy and Insolvency Act on insolvency decisions. Rule changes steered debtors out of division I proposals and into the more cost-effective division II proposals. This also led to a significant substitution out of bankruptcies and into proposals. Using credit bureau data on credit card limits we test, but do not find, any evidence that this substitution into more creditor-friendly insolvencies had any impact on average lending behavior, either immediately following the amendments or up to six years removed.
    Keywords: Credit and credit aggregates, Financial Institutions, Financial system regulation and policies
    JEL: D14 G2 K35
    Date: 2016
  12. By: Fang, Yiwei; Hasan, Iftekhar; Li, Lingxiang
    Abstract: ​The dynamic banking reforms of Central and Eastern Europe (CEE) following the collapse of the Soviet Union provide an ideal research setting for examining the causal effect of institutional development on financial reporting. Using five earnings quality measures, we consistently find that banking reform improves accounting quality and reduces earnings management incentives in the 16 transition countries considered. The results strongly hold in our within-country and difference-in-difference models, as well as in non-parametric analyses. We also find supporting evidence for the notion that excessive risk-taking of banks impairs earnings quality. As a result, banking reform improves earnings quality partially through its ability to curb risk-taking behavior. Publication keywords: earnings management, earnings quality, institutional development, bank risk-taking
    JEL: G18 M41 M48 G38 E50 G15
    Date: 2014–12–01
  13. By: Micossi, Stefano; Bruzzone, Ginevra; Cassella, Miriam
    Abstract: This paper discusses the application of the new European rules for burden-sharing and bail-in in the banking sector, in view of their ability to accommodate broader policy goals of aggregate financial stability. It finds that the Treaty principles and the new discipline of state aid and the restructuring of banks provide a solid framework for combating moral hazard and removing incentives that encourage excessive risk-taking by bankers. However, the application of the new rules may have become excessively attentive to the case-by-case evaluation of individual institutions, while perhaps losing sight of the aggregate policy needs of the banking system. Indeed, in this first phase of the banking union, while large segments of the EU banking sector still require a substantial restructuring and recapitalisation, the market may not be able to provide all the needed resources in the current environment of depressed profitability and low growth. Thus, a systemic market failure may be making the problem impossible to fix without resorting to temporary public support. But the risk of large write-offs of capital instruments due to burden-sharing and bail-in may represent an insurmountable obstacle to such public support as it may set in motion an investors’ flight. The paper concludes by showing that existing rules do contain the flexibility required to accommodate aggregate policy requirements in the general interest, and outlines a public support scheme for the precautionary recapitalisation of solvent banks that would be compliant with EU law.
    Date: 2016–04
  14. By: Hasan, Zubair
    Abstract: Islam banishes interest. This raises two questions contextual to Central Banking. First, can Islamic banks create credit like the conventional? We shall argue that Islamic banks cannot avoid credit creation; an imperative for staying in the market where they operate in competition with their conventional rivals. Evidently, the interest rate policy would not be applicable to them as a control measure. This leads us to the second question: What could possibly replace the interest rate for Islamic banks? In reply, the paper suggests what it calls a leverage control rate (LCR) as an addition to Central Banks’ credit control arsenal. The proposed rate is derived from the sharing of profit ratio in Islamic banking. It is contended that the new measure has an edge over the old fashioned interest rate instrument which it can in fact replace with advantage. It can possibly be a common measure in a dual system.
    Keywords: Central Banking; Credit creation; leverage control rate. (LCR); Islamic banks; Profit sharing
    JEL: G0 G01 G2 G28
    Date: 2016–01
  15. By: Gary Gorton; Tyler Muir
    Abstract: The pre-crisis financial architecture was a system of mobile collateral. Safe debt, whether government bonds or privately produced bonds, ie asset-backed securities, could be traded, posted as collateral, and rehypothecated, moving to its highest value use. Since the financial crisis, regulatory changes to the financial architecture have aimed to make collateral immobile, most notably with the BIS "liquidity coverage ratio" for banks. In the face of the Lucas critique, how should these policies be evaluated? We evaluate this immobile capital system with reference to a previous regime, which had this feature: the US National Banks Era.
    Keywords: Liquidity regulation, collateral, policy evaluation with economic history
    Date: 2016–05
  16. By: Frederic Boissay; Russell Cooper
    Abstract: Active wholesale financial markets help reallocate deposits across heterogeneous banks. Because of incentive problems, these flows are constrained and collateral is needed. Both the volume, the value, and the composition of collateral matter. We make a distinction between "outside collateral" and "inside collateral". The use of inside assets, such as loans, creates a "collateral pyramid", in that cash flows from one loan can be pledged to secure another. Through collateral pyramids the financial sector creates safe assets, but at the cost of exposing the economy to systemic panics. Outside collateral, such as treasuries, serves as foundation of, and stabilises, the pyramid. There is a threshold for the volume of treasuries, below which investors panic, the pyramid collapses, and there is not enough safe assets to support wholesale market activity; a situation that we call "collateral trap".
    Keywords: Banking crisis, collateral composition
    Date: 2016–06
  17. By: G. Gaballo; A. Zetlin-Jones
    Abstract: We show that an increase in banks' holdings of domestic Sovereign debt decreases the ability of domestic Sovereigns to successfully enact bailouts. When Sovereigns finance bailouts with newly issued debt and the price of Sovereign debt is sensitive to unanticipated debt issues, then bailouts dilute the value of banks' Sovereign debt holdings rendering bailouts less effective. We explore this feedback mechanism in a model of financial intermediation in which banks are subject to managerial moral hazard and ex ante optimality requires lenders to commit to ex post inefficient bank liquidations. A benevolent Sovereign may desire to enact bailouts to prevent such liquidations thereby neutralizing lenders' commitment. In this context, home bias for Sovereign debt may arise as a mechanism to deter bailouts and restore lenders' commitment.
    Keywords: Bailout, Sovereign debt, Home bias, Time inconsistency, Commitment, Macroprudential regulation.
    JEL: E0 E44 E6 E61
    Date: 2016
  18. By: Niklas Amberg; Tor Jacobson; Erik von Schedvin; Robert Townsend
    Abstract: Using data on exogenous liquidity losses generated by the fraud and failure of a cash-in-transit firm, we demonstrate a causal impact on firms’ trade credit usage. We find that firms manage liquidity shortfalls by increasing the amount of drawn credit from suppliers and decreasing the amount issued to customers. The compounded trade credit adjustments are at least as great, if not greater than corresponding adjustments in cash holdings, suggesting that trade credit positions are economically important sources of reserve liquidity. The underlying mechanism in trade credit adjustments is in part due to shifts in credit durations—both upstream and downstream.
    JEL: D22 G30
    Date: 2016–05
  19. By: Claus Thustrup Kreiner (Department of Economics, University of Copenhagen); Søren Leth-Petersen,; Louise C. Willerslev-Olsen (Department of Economics, University of Copenhagen)
    Abstract: Do people end up in financial trouble simply because of adverse shocks to income and wealth, or is financial trouble related to persistent differences in financial attitudes and behavior that may be transmitted from generation to generation? We address this question using a new administrative data set with longitudinal information about defaults for the universe of personal loans in Denmark. We provide non-parametric evidence showing that the default propensity is more than four times higher for individuals with parents who are in default compared to individuals with parents not in default. This intergenerational relationship is apparent soon after children move into adulthood and become legally able to borrow. The intergenerational relationship is remarkably stable across age groups, levels of loan balances, parental income levels, childhood school performance, time periods and different measures of financial trouble. Basic theory points to three possible explanations of the correlation across generations in financial trouble: ( i ) children and parents face common shocks; (ii ) children and parents insure each other against adverse shocks; (iii ) nancial behavior diers across people and is transmitted across generations. Our evidence indicates that the last explanation is the most important. Finally, we show that the intergenerational correlation in financial trouble is not fully incorporated in interest setting on loans, pointing to adverse selection in the market for personal loans.
    Date: 2016–05–18
  20. By: Christoph Aymanns; Fabio Caccioli; J. Doyne Farmer; Vincent W.C. Tan
    Abstract: We investigate a simple dynamical model for the systemic risk caused by the use of Value-at-Risk, as mandated by Basel II. The model consists of a bank with a leverage target and an unleveraged fundamentalist investor subject to exogenous noise with clustered volatility. The parameter space has three regions: (i) a stable region, where the system has a fixed point equilibrium; (ii) a locally unstable region, characterized by cycles with chaotic behavior; and (iii) a globally unstable region. A calibration of parameters to data puts the model in region (ii). In this region there is a slowly building price bubble, resembling the period prior to the Global Financial Crisis, followed by a crash resembling the crisis, with a period of approximately 10-15 years. We dub this the Basel leverage cycle. To search for an optimal leverage control policy we propose a criterion based on the ability to minimize risk for a given average leverage. Our model allows us to vary from the procyclical policies of Basel II or III, in which leverage decreases when volatility increases, to countercyclical policies in which leverage increases when volatility increases. We find the best policy depends on the market impact of the bank. Basel II is optimal when the exogenous noise is high, the bank is small and leverage is low; in the opposite limit where the bank is large and leverage is high the optimal policy is closer to constant leverage. In the latter regime systemic risk can be dramatically decreased by lowering the leverage target adjustment speed of the banks. While our model does not show that the financial crisis and the period leading up to it were due to VaR risk management policies, it does suggest that it could have been caused by VaR risk management, and that the housing bubble may have just been the spark that triggered the crisis.
    Keywords: Financial stability; capital regulation; systemic risk
    JEL: G11 G20
    Date: 2016–03–03
  21. By: Kenjiro Hori (Department of Economics, Mathematics & Statistics, Birkbeck); Jorge Martin Ceron (Department of Economics, Mathematics & Statistics, Birkbeck)
    Abstract: The convex payoffs for equityholders in a corporate structure results in agency costs and moral hazard problems. The implicit government guarantee for banks accentuates these. We believe that the Basel III related bail-in contingent convertible (CoCo) structures do only not solve these problems, but may even aggravate them. In this paper we suggest solutions. The first is to replace the currently issued writedown/off and equity-conversion CoCo structures with a market-price equity-conversion CoCo bonds. This mirrors the full dilution effect of an ordinary equity raise in a distressed situation to reduce incentives for high risk-taking by equityholders. The second is to establish a Contingent Equity Base that replaces the incumbent shareholders once the CoCo is triggered. This will finally remove the perverse risk-taking incentives. The valuation of the CEB is then suggested.
    Keywords: CoCo bond, agency costs, moral hazard, bail-in, cost of equity.
    JEL: D82 G21 G28 G32
    Date: 2016–02
  22. By: Martin Guzman (Columbia University); Peter Howitt (Brown University)
    Abstract: This paper analyzes what assumptions on formation of expectations are consistent with Minsky’s Financial Instability Hypothesis (FIH) and its corollaries. The FIH establishes that financial relations evolve over time turning a stable system into an unstable one. Financial crises would be more likely to occur, and more severe if they occur, the longer the previous crisis recedes into the past. We show that the hypothesis is consistent with assumptions on formation of expectations that imply learning from realization of states and inconsistent with the assumption of full information rational expectations.
    Keywords: Wealth distribution, income distribution, Cambridge theory.
    JEL: D84 E32 F34 G01
    Date: 2015–12

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