Financial cascades in the mena region : theory, empirics and policy

Abstract EN

We develop a randomized analytical model of financial herds and cascades, which we first numerically simulate and later empirically test for a panel of 12 MENA countries among a sample of 35 markets from 2000 to 2009.

Financial Cascades, i.e., information free riding behavior, occur when uncertainty is high and markets are opaque.

Monte Carlo simulation of the model shows that when traders or investors readily update the “reservation price” and reservation sell to buy ratio” (points at which they sell or to buy), based on new market data, an inverted-U pattern emerges, depicting the effect of market transparency on volatility.

In this pattern, increased financial transparency actually increases market volatility at first, only to reduce it later at higher levels of financial transparency.

This first (upward) portion seems consistent with the Furman-Stiglitz (1998) thesis that more frequent news and information intensifies volatility, while the second (downward) portion of the inverted-U follows the more conventional wisdom exemplified by the International Monetary Fund’s position on opacity as the cause of cascades.

Of our two measures of financial transparency that we use, “the strength of audit”, and “the transparency of government policy”, the first variable provides strong support for our inverted U theory for the full sample of 35 countries and for our sample of 12 MENA countries.

The transparency of government policy variable, while sometimes beneficial in promoting financial stability is neither as robust in this aspect, nor as robust in support of the inverted U theory.