Abstract

CRUZ-AKE, Salvador; LOPEZ SARABIA, Pablo  and  VENEGAS-MARTINEZ, Francisco. Financial volatility and banking system during the 2007-2009 crisis. Inv. Econ [online]. 2011, vol.70, n.276, pp.89-124. ISSN 0185-1667.

This paper aims to provide a multifactor explanation about the financial crisis of 2007-2009, triggered by the failure of subprime mortgages, and the afterwards high volatility in the financial markets. The behavior of banks that suspended operations in hedge funds with backed or collateralized mortgages is examined, which in turn led to a lack of liquidity in the financial system, a situation that drove the state to rush a rescue. To reach this end, we propose a system of stochastic differential equations with mean reversion linking the capital requirement of banks to: risky assets, the volatility of the financial system, the risk premium market, the real interest rate, the level of inflation, and economic activity. The proposed model assumes that banks may suffer "bank runs" when their capital requirements is below a VaR (value at risk) threshold, and the effects of the "run" can be transmitted to the rest of the financial system. Additionally, by using Monte Carlo simulation, it is shown that the irresponsible behavior of banks can influence a breakdown of the rest of the system, depending on their relative size.

Keywords : volatility models; financial crisis; banks system.