Learning from History: Volatility and Financial Crises

Abstract

We study the effects of volatility on financial crises by constructing a cross-country database spanning over 200 years. Volatility is not a significant predictor of crises whereas unusually high and low volatilities are. Low volatility is followed by credit build-ups, indicating that agents take more risk in periods of low financial risk consistent with Minsky hypothesis, and increasing the likelihood of a banking crisis. The impact is stronger when financial markets are more prominent and less regulated. Finally, both high and low volatilities make stock market crises more likely, while volatility in any form has no impact on currency crises.