Financial Shock Model Could Lead to Forecasts of Crises, Says MU Researcher

The NSF recently awarded Christopher Otrok a grant to complete the model

August 8th, 2012

COLUMBIA, Mo. — Greece’s current debt crisis is only the latest of the financial shocks that have been bouncing back and forth across the Atlantic and around the world since the beginning of the financial crisis in 2007. University of Missouri economist Christopher Otrok is working on a mathematical model designed to help explain the way financial shocks, or sudden drastic changes in the economy, spread from one country to another. Otrok’s model could eventually lead to ways of forecasting shocks and minimizing the damage they cause.

“The model we are developing will help explain how shocks function in the global economy and why certain economies react differently than others,” said Otrok. “For example, after the financing and housing collapse in the U.S. led to a global crisis, developing economies, like India and Brazil, bounced back sooner than developed economies. These developing economies are now significant drivers of the global economy; and the model will help explain how globalization has changed the relationships among nations since the ‘80s.”

The National Science Foundation recently awarded Otrok $70,600 to develop a financial shock model. The model will answer key questions about how globalization has interwoven the world’s economies. It will help define the means by which shocks move among nations. The reaction of individual sectors of economies, such as manufacturing and medical services, to shocks in other sectors also will be incorporated into the model.

“Once the model is developed, it could be used to develop a means of forecasting shocks,” said Otrok. “Policy makers could then use the model for guidance as they create the monetary and fiscal policies designed to minimize the impact of the shock. Ideally, a global strategy on how to deal with shocks could reduce the chances of another major financial crisis.”

This year, Otrok noted that the American agricultural sector may be the cause of an economic disturbance due to the drought. Failed crops may affect other sectors by increasing food prices and raising demand for imports.

Chistopher Otrok is professor and the Sam B. Cook Chair in Economics in MU’s Department of Economics in the School of Arts and Science.