On the Determinants of the 2008 Financial Crisis: A Bayesian Approach to the Selection of Groups and Variables

We consider the determinants of the 2008 crisis and address two main forms of model uncertainty: The uncertainty in selecting theoretical groups and the uncertainty in selecting explanatory variables. We introduce Bayesian hierarchical formulation that allows for the joint treatment of group and variable selection using the Group-wise Gibbs sampler. Our group variable selection shows that pre-crisis financial policies and trade linkages play a particularly important role in explaining the severity of the crisis, alongside institutions, and within the selected groups we identify a broader set of variables correlated with the crisis, which in turn leads to an improvement in prediction performance. In the robustness analysis we also find that our results are not qualitatively changed on alternative measures of crisis intensity, different groupings of variables, or prior assumptions. We further argue that the established results in the literature may well be attributed to different prior choices used in the analysis.