Modeling of Financial Crises : A Critical Analysis of Models Leading to the Global Financial Crisis

The causes of financial crises are multiple but the models of financial crises revolve around four generational models. In this paper, the authors analyzed these models and highlighted the fact that each model was adapted to specific situations to explain the financial crises faced rather than being visionary or systematic in approach. These models suggest crises may develop without significant change in economic fundamentals, since policies usually respond to changes in economy and agents consider these when forming expectations. Therefore, any set of indicators together may not provide an over-all picture but interactions among indicators should be pursued. Common sense and guesswork is used but is not sufficient for representing real behavior. Modeling suggests that stressed or fraudulent companies should be removed to avoid further crises. While the new models handle a wider range of nonlinear behavior, little new work is in fact evident. Apart from a patchwork-like approach of the past, financial or currency crises modeling has not been dealt with systematically. A new way thinking is not emerging suggesting a visionary and dynamic robust mathematical modeling approach is needed with attention to the many possible risks