A Markov chain measure of systemic banking crisis frequency

Abstract

This study nests historical evidence for credit growth-fuelled financial instability in a two-state nonhomogeneous Markov chain with logistic crisis incidence. A long-run frequency measure is defined and calibrated for 17 advanced economies from 1870 to 2016. It is found that historical (implied) crisis frequencies display a V (J) pattern over time. A key implication is that policies strengthening capital adequacy contribute more to systemic stability than expanding deposit insurance or curbing sustained credit booms.