Abstract
AbstractThe Financial Instability Hypothesis posits that debt, and the validation of debt characterizes the state of the economy. A Minsky Moment is a swift collapse of asset prices after a long period of debt‐fueled growth. Current literature lacks empirical analysis to validate the Financial Instability Hypothesis with respect to stock market crashes and financial crises. Based on Vercelli’s (2009) interpretation, Minskys’ characterization of debt validation is based on two indices. This first index depicts the current liquidity of a firm. The second index depicts the expected solvency of a firm. Both the liquidity index and the solvency index can be calulated using financial statement data. Using Compustat data from 1982 to 2015 in a probit regression model, this paper supports how the role of debt and how the change in the validation of debt predict a stock market crash and an onset of a recession. This study contributes to the existing literature by being the first study to support the validity of the Financial Instability Hypothesis using financial statement data and by creating a model to predict future stock crashes and recessions.
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