Stormy financial landscape with money trees.

Is Financial Speculation Making Our Economy More Unstable? Here’s What You Need to Know

Theo Raines in Business & Economy December 2025 • 4 min read.

"Dive into the world of financial speculation and its surprising impact on economic stability. Learn how risky assets and market behaviors can shape our financial future."

Throughout history, economies have seen large swings in asset prices, often accompanied by significant fluctuations in overall economic activity. One common factor before major economic downturns is the introduction of new financial products. A prime example is the period leading up to the 2008 financial crisis, which saw the emergence of complex structured bonds and securitized products. The lure of high returns attracted many to these riskier investments, creating large-scale economic effects.

A recent study delves into the impact of financial speculation, presenting a macroeconomic model that highlights key points. First, fluctuations in asset prices and economic activity are often driven by the repeated appearance and disappearance of risky financial assets, rather than just expansions and contractions in credit availability. Second, in economies with ample borrowing and lending, the emergence of risky financial assets can decrease productive capital. Conversely, in economies with limited borrowing and lending, it may lead to increased productive capital.

The research builds on existing literature in macro-finance, which emphasizes the role of credit availability in business fluctuations. This includes seminal work by Stiglitz and Weiss (1981), Bernanke (1983), and Greenwald, Stiglitz, and Weiss (1984). While this body of work focuses on credit availability, the new model focuses on how the recurrent appearance and disappearance of risky financial assets can create large-scale and stochastic macroeconomic fluctuations.

What Role Do Risky Financial Assets Play?

Stormy financial landscape with money trees.

In this model, the presence of risky financial assets is closely tied to real-world assets, specifically trees that yield dividends. When these trees are alive, they provide a stream of income, influencing the economy. However, there's also a chance that an aggregate shock could wipe out these assets, causing them to yield nothing and effectively disappear from the market. This dynamic environment, where assets appear and disappear stochastically, drives much of the economic fluctuation.

To simplify the analysis, the model starts with an economy where borrowing and lending are not possible. This assumption helps highlight how the mere presence of risky assets, rather than the availability of credit, can drive macroeconomic fluctuations. Later, borrowing and lending are introduced to explore how these factors interact.

Here are some key aspects of how risky financial assets affect the economy:

Asset Valuation: The price of these assets (trees) is determined endogenously in the model, reflecting their potential to yield dividends.
Aggregate Shocks: The probability of an aggregate shock, which causes the assets to become worthless, introduces uncertainty and drives economic fluctuations.
New Market Entrants: After an aggregate shock, new entrepreneurs enter the economy with new types of trees, reintroducing risky assets into the market.

The model also considers how entrepreneurs invest and consume in this environment. Entrepreneurs can invest in projects with varying productivity levels, and their decisions are influenced by the returns from holding risky assets. This interplay between investment and asset holding drives the dynamics of the economy.

What Does It All Mean?

This research offers valuable insights into the complex relationship between financial speculation and economic stability. By understanding how risky assets and market behaviors interact, we can better prepare for and manage the fluctuations that inevitably arise in a dynamic economy. The model suggests that the impact of risky financial assets can vary depending on factors such as borrowing conditions and the productivity of investments, highlighting the need for nuanced approaches to economic policy.

About this Article -

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This article is based on research published under:

DOI-LINK: https://doi.org/10.48550/arXiv.2408.05047,

Title: Recurrent Stochastic Fluctuations With Financial Speculation

Subject: econ.th

Authors: Tomohiro Hirano

Published: 09-08-2024

Everything You Need To Know

What is the primary driver of economic fluctuations in the model presented, and how does it differ from traditional views?

The primary driver of economic fluctuations, according to the model, is the recurrent appearance and disappearance of risky financial assets. This contrasts with traditional views that emphasize expansions and contractions in credit availability as the main cause. The model suggests that these risky assets, represented by trees that yield dividends, introduce stochasticity through aggregate shocks, causing them to become worthless and thus driving economic cycles.

How do risky financial assets, like the dividend-yielding trees, influence the economy within the model?

In the model, risky financial assets, specifically dividend-yielding trees, have a direct impact on the economy. The price of these assets is determined endogenously, based on their potential to yield dividends. The risk comes from aggregate shocks, which can wipe out these assets, making them worthless. Entrepreneurs invest and consume based on the returns from these risky assets, which then drives the economic dynamics. The stochastic nature of the assets introduces uncertainty, which is a core component of the model's economic fluctuations.

What role does borrowing and lending play in the context of risky financial assets, and how does it affect productive capital?

The model initially simplifies the economy by assuming no borrowing or lending to highlight the impact of risky assets. When borrowing and lending are introduced, the model shows that the presence of risky financial assets can have varying effects on productive capital. In economies with ample borrowing and lending, the emergence of risky financial assets can decrease productive capital. Conversely, in economies with limited borrowing and lending, the same assets may lead to increased productive capital. This indicates that the interaction between risky assets and credit conditions is crucial for overall economic health.

Can you explain the concept of aggregate shocks within the model and its implications for the economy?

In the model, aggregate shocks represent the possibility that risky financial assets, like dividend-yielding trees, can become worthless. This introduces uncertainty and drives economic fluctuations. The aggregate shocks cause these assets to yield nothing and effectively disappear from the market. These shocks have significant implications because they influence entrepreneurs' investment decisions and the overall market valuation of assets. The probability of these shocks is a critical factor in determining the level of economic instability.

How can understanding the interplay between risky assets and market behaviors help in managing economic fluctuations?

Understanding the interplay between risky assets and market behaviors is crucial for managing economic fluctuations. By recognizing how risky financial assets drive market dynamics, policymakers can better prepare for and respond to economic downturns. The model suggests that the impact of risky financial assets depends on factors like borrowing conditions and investment productivity. This knowledge allows for the development of nuanced economic policies tailored to specific conditions, promoting stability and mitigating the adverse effects of asset price swings and economic downturns. For example, this understanding could help design regulations and monitoring systems to manage the emergence of risky assets and prevent systemic risks.