Separation of Markets and Financial Instability: a Closer Look to Classical Dichotomy


Several financial crises occurred over the past three decades have provoked debate in the literature of liberalization and deregulation of financial markets. By surveying the theory of classical dichotomy and its critiques, the notion of “separation” between the financial and real sectors has been introduced in this article. It argues that the existence and expansion of this separation will lead to financial crisis. In order to identify the separation “price-to-earnings ratio” index has been proposed. By applying the data of Tehran’s Stock Exchange during 2002:2-2015:1, several episodes of this separation were recognized. Considering the factors which cause the expansion of the separation, it is essential to reestablish regulations and mechanisms of financial markets in a way that reduces the separation and hence lessen financial crises. Islamic financial rules can provide economic system with mechanisms which bring harmony between the real and the financial sector.


financial markets speculation price bubble separation financial crisis