Financial Market Meltdown: Evidence from the Collapse of Icelandic Banks

In the wake of recent unprecedented worldwide stock market turmoil and financial meltdown, Iceland has been pushed to the brink of national bankruptcy with the collapse of its banking industry. What went wrong? We document various insights and perspectives on the collapse of the Icelandic banking and financial sectors through our interviews of Icelandic bankers, ordinary investors, and politicians. We examine various key indicators before the financial crisis in Iceland and introduce an alternative method for measuring the downside risk of the financial and banking sectors. We use a mean-semivariance approach for measuring the downside risk in Icelandic stock investment from the perspective of a risk-averse international portfolio investor. By comparing the downside risks as well as systematic risks for investing in Icelandic stock index OMX15 and in particular Icelandic financial and banking stock index vis a vis several benchmark indexes in larger stock markets such as Nordic stock benchmark indexes and S&P 500 indexes, we show that the mean-semivariance approach provides a reasonable prediction before the Icelandic banking collapse.