Measurement on Financial Risks Based on Catastrophe Model

Abstract

With the accelerating of capital flow and frequent financial crisis, theories on crisis and early warning models have been developed since 1970s. So far, there are four generations of such theories: the first generation of crisis theory, formulated by Kugman, used official foreign currency reserve, excessive domestic credit, central bank’s loan to public sectors, entire budget deficit, central bank’s loan to financial institutions as indices to forecast monetary crisis. The second, proposed by Obsfeld, added some indices: output level, foreign and domestic interest rate, indices about banking system and political variables to forecast crisis. The third suggested that the financial sectors can by themselves trigger monetary crisis due to their fragility. The fourth, advanced by Kugman, emphasized the importance of capital price. This paper constructs a catastrophe model of measurement and pre-warning of the financial risks according to the catastrophe theory.