Financial Catastrophe

Abstract

In the previous chapter we discussed the concept of catastrophe — the low probability, high severity event that can assume natural or man-made form. We now leave aside earthquakes, river floods, and politico-religious terrorist bombings and move to the heart of this book by focusing on the important subcategory of financial catastrophes. In this chapter, we consider the financial catastrophe by first describing some of the characteristics that distinguish it from its natural counterparts, then analyzing how in a theoretical way such disasters may arise, and then reflecting on how institutional and systemic bodies might react to such an event. We conclude with an overview of the historical experience regarding financial catastrophes. Since this is our first detailed look at the topic, we describe the issue in its conceptual light — saving our practical analysis of “real-life” events for Part III.