Business Cycles as Collective Risk Fluctuations

TL;DR

This paper models business cycles as collective risk fluctuations in an economic domain, using risk ratings and flow equations to explain macroeconomic oscillations.

Contribution

It introduces a novel continuous risk-based framework for modeling economic agent interactions and business cycles through flow equations in risk space.

Findings

Flow fluctuations cause business and credit cycles.

Derived equations describe supply-demand cycle oscillations.

Model links risk dynamics to macroeconomic fluctuations.

Abstract

We suggest use continuous numerical risk grades [0,1] of R for a single risk or the unit cube in Rn for n risks as the economic domain. We consider risk ratings of economic agents as their coordinates in the economic domain. Economic activity of agents, economic or other factors change agents risk ratings and that cause motion of agents in the economic domain. Aggregations of variables and transactions of individual agents in small volume of economic domain establish the continuous economic media approximation that describes collective variables, transactions and their flows in the economic domain as functions of risk coordinates. Any economic variable A(t,x) defines mean risk XA(t) as risk weighted by economic variable A(t,x). Collective flows of economic variables in bounded economic domain fluctuate from secure to risky area and back. These fluctuations of flows cause time oscillations of macroeconomic variables A(t) and their mean risks XA(t) in economic domain and are the origin of any business and credit cycles. We derive equations that describe evolution of collective variables, transactions and their flows in the economic domain. As illustration we present simple self-consistent equations of supply-demand cycles that describe fluctuations of supply, demand and their mean risks.