I received an interesting-looking paper which I converted to PDF and posted at www.ederman.com…

Avoiding Economic Crises via the Stochastic Money Supply

Falip. O. Lor Ph.D1,2

[version: 1.4.09]

Abstract

We generalise the arguments of Minsky to propose a stochastic differentialequation (SDE) using GBM for modelling the domestic money supply and its effect on GDP via the velocity of money v. Using Prospect Theory?s positive convexity of investors? risk preferences under framing losses, and assuming the scaling behavior of the black tails of asset returns, we can show that positive feedback loop leading to bubbles in the economies can be dampable if central banks will take action to limit the volatility of volatility of v.

We solve our equation in discreet time via simulation involving cellular automata. Extending the stochastic behavior of money supply to allow for Levi-Khinchine processes, we have used Malliavin calculus to demonstrate that our results still hold true in aggregate.

Finally, we propose a new risk measure, CVaR-V, measuring the bubble risk in a domestic economy. Assuming the validity of the Black-Litterman model, we extend our results to economies of several coupled countries for all logarithmic utility functions.

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1. Current affiliation: Lecturer, Dept of Economics, Universidad Sao Seriffe. Also Adjunct Lecturer in Physics, SS Istituta di Tecnologia.

2. Supported in part by grant from Departamento di Energia & Sanidad, SS.