systemic risk

• Systemic Risk

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Hedge funds - Systemic risk

1 Organizations such as the National Bureau of Economic Research and the European Central Bank have charged

that hedge funds pose systemic risks to the financial sector, and following the

failure of hedge fund Long-Term Capital Management (LTCM) in 1998 there was widespread concern about the potential for systemic risk if a hedge fund failure led to the failure of its counterparties


Hedge funds - Systemic risk

1 These systemic risk concerns are exacerbated by the prominent role of hedge funds in the financial markets


Systemic risk

1 Dwyer It can be defined as financial system instability, potentially catastrophic, caused or exacerbated by

idiosyncratic events or conditions in financial intermediaries.[https://www.newyorkfed.org/registrati

on/research/risk/Daula_slides.ppt Systemic Risk: Relevance, Risk Management Challenges and Open Questions], Tom Daula It refers to the risks imposed

by interlinkages and interdependencies in a system or market, where the failure of a single entity or cluster of entities can cause a cascading failure, which could potentially bankrupt or bring down the entire system or market.[http://papers.ssrn.com/sol3/papers.cfm?

abstract_id=1008326 Systemic Risk], Steven L


Systemic risk - Explanation

1 These interlinkages and the potential clustering of bank runs are the issues which policy makers consider when addressing the issue of protecting a

system against systemic risk.[http://www.crmpolicygroup.org/docs/CRMPG-III.pdf Containing Systemic Risk], CRMPG III, August 6, 2008 Governments and market monitoring institutions (such

as the U.S



1 Systemic risk should not be confused with market or price risk as the latter is specific to the item being bought

or sold and the effects of market risk are isolated to the entities dealing in that specific item. This kind of risk can be mitigated by hedging an

investment by entering into a mirror trade.



1 Insurance is often easy to obtain against systemic risks because a party issuing that insurance can

pocket the premiums, issue dividends to shareholders, enter

insolvency proceedings if a catastrophic event ever takes place,

and hide behind limited liability. Such insurance, however, is not effective for the insured entity.



1 One argument that was used by financial institutions to obtain special advantages in bankruptcy for derivative contracts was a claim that the market is both critical and

fragile.[http://www.independent.org/pdf/tir/tir_07_3_scott.pdf What is Systemic Risk]

[http://mises.org/media/4014 The Economics of Legal Tender Laws], Jorg Guido Hulsmann (includes detailed commentary on systemic risk inherent in fractional reserve banking|

FRB)



1 With respect to federal financial regulation, the systemic risk of a financial institution is the

likelihood and the degree that the institution's activities will negatively affect the larger

economy such that unusual and extreme federal intervention would be required to ameliorate the effects.[http://www.pciaa.net/web/sitehome.nsf/l

cpublic/392/$file/PCI_Systemic_Risk_Definition.pdf Systemic

Risk], Property Casualty Insurers Association of America



1 A general definition of Systemic Risk which is not limited by its mathematical approaches,

model assumptions or focus on one institution; and which is also the first

operationalizable definition of Systemic Risk encompassing the systemic character of

financial, political, environmental, and many other risks is available since

2010.[http://ssrn.com/abstract=1620495 Market Dynamics Systemic Risk], Milan

Boran


Systemic risk - TBTF/TICTF

1 The impact is also dependent on how correlated an institution's

business is with other systemic risks.[http://www.pciaa.net/web/sitehome.nsf/lcpublic/392/$file/PCI_Systemic_Ri

sk_Definition.pdf PCI Definition of Systemic Risk]


Systemic risk - TBTF/TICTF

1 It is also dependent on how correlated an institution's business is

with other systemic risk.[http://www.pciaa.net/web/sitehome.nsf/lcpublic/392/$file/PCI_Systemic_Risk_Definition.pdf Too Big to Fail],

Property Casualty Insurers Association of America


Systemic risk - SRISK

1 Volatility, correlation and tails for systemic risk measurement,

[http://ssrn.com/abstract=1611229] build a systemic risk measure named

SRISK



1 Systemic Risk in Europe] allows for various factors, time varying

parameters, and is therefore more adapted to the European market



1 The SRISK Systemic Risk Indicator is computed automatically on a weekly

basis and made available to the community. For the US model SRISK and other statistics may be found

under the [http://vlab.stern.nyu.edu/ Volatility Lab of NYU Stern School]

website and for the European model under the [http://www.crml.ch/

Center of Risk Management (CRML)] website of HEC Lausanne.


Systemic risk - Factors

1 Factors that are found to support

systemic risks are:



1 # Economic implications of models are not well understood. Though

each individual model may be made accurate, the facts that (1) all models

across the board use the same theoretical basis, and (2) the relationship between financial

markets and the economy is not known lead to aggravation of

systemic risks.https://store.theartofservice.com/the-systemic-risk-toolkit.html


1 # Liquidity risks are not accounted for in pricing models used in trading on the financial markets. Since all

models are not geared towards this scenario, all participants in an illiquid market using such models will face

systemic risks.


Systemic risk - Diversification

1 Participants in the market, like hedge funds, can be the source of an

increase in systemic risk[http://web.mit.edu/alo/www/Pape

rs/systemic2.pdf Systemic risk and hedge funds] and transfer of risk to them may, paradoxically, increase

the exposure to systemic risk.


Systemic risk - Diversification

1 challenge this view, investigating conditions under which

diversification may have ambiguous effects on systemic

risk.[http://www.bankofengland.co.uk/archive/Documents/historicpubs/

speeches/2009/speech386.pdf Rethinking the Financial Network]


Systemic risk - Regulation

1 Thus the systemic risk migrated from one sector to another and proves

that regulation of only one industry cannot be the sole protection against

systemic risks.


Systemic risk - Project risks

1 They may also be driven by the level of technology in a project or the

complexity of a project's scope or execution

strategy.[http://www.c4ce.com/AACE_Risk_Hollmann_paper.pdf Systemic

Risks in Projects]


Systemic risk - Systemic risk and insurance

1 In February 2010, international insurance economics think tank, The Geneva Association, published a 110-page

analysis of the role of insurers in systemic risk.[http://www.genevaassociation.org/PDF/BookandMonographs/Geneva_Association_Systemic_Risk_in_Insurance_Report_March2010.pdf Systemic Risk in Insurance—

An analysis of insurance and financial stability (2010) The Geneva Association]



1 In the report, the differing roles of insurers and banks in the global financial system and their

impact on the crisis are examined (See also CEA report, Why Insurers Differ from

Banks).[http://www.cea.eu/uploads/DocumentsLibrary/documents/1277383780_cea-report-

insurance-a-unique-sector.pdf CEA (June 2010) Insurance: a unique sector—Why Insurers Differ from Banks] A key conclusion of the analysis is

that the core activities of insurers and reinsurers do not pose systemic risks due to the specific

features of the industry:



1 Applying the most commonly cited definition of systemic risk, that of the Financial Stability Board (FSB), to the

core activities of insurers and reinsurers, the report concludes that none are systemically relevant for at least one of the following reasons:



1 For most classes of insurance, however, there is little evidence of insurance either

generating or amplifying systemic risk, within the financial system itself or in the

real economy.”IAIS (June 2010) [http://www.iaisweb.org/__temp/IAIS_Position_Statement_on_Key_Financial_Stability_I

ssues.pdf International Association of Insurance Supervisors (IAIS) position

statement on key financial stability issues]



1 Other organisations such as the CEA and the Property Casualty Insurers

Association of America (PCI)PCI (2009)

[http://www.pciaa.net/web/sitehome.nsf/lcpublic/392/$file/PCI_Systemic_Ri

sk_Definition.pdf Systemic Risk Defined] have issued reports on the

same subject.


Systemic risk - Discussion

1 Chairman Barney Frank has expressed concerns regarding the vulnerability of highly-leveraged financial systems to systemic risk and the US

government has debated how to address financial services regulatory reform and systemic risk.

[http://www.pciaa.net/Publish/Web/webpress.nsf/lookupwebcontent/

F885A1302118898E8625755A007BC48?opendocument Systemic Risk

Focus][http://www.pciaa.net/Publish/Web/webpress.nsf/lookupwebcontent/

BDACACC7FE8E86B28625755A005C8C5?opendocument Addressing Systemic Risk]


Systemic risk - Further reading

1 *Gray, Dale F. and Andreas A. Jobst, 2009, Higher Moments and

Multivariate Dependence of Implied Volatilities from Equity Options as

Measures of Systemic Risk,” Global Financial Stability Report, Chapter 3,

April (Washington: International Monetary Fund), pp.128–31.



1 *Gray, Dale F., Andreas A. Jobst, and Samuel Malone, 2010, “Quantifying

Systemic Risk and Reconceptualizing the Role of Finance for Economic Growth,” Journal of Investment

Management, Vol. 8, No.2, pp.90–110.



1 * Jobst, Andreas A., 2012, [http://ssrn.com/abstract=2022062

Systemic Risk in the Insurance Sector-General Issues and a First Assessment of Large Commercial

(Re-)Insurers in Bermuda], Working paper (March 14).



1 * Zeyu Zheng, Boris Podobnik, Ling Feng and Baowen Li, Changes in Cross-Correlations as an Indicator for

Systemic Risk [http://www.nature.com/srep/2012/121126/srep00888/full/srep00888.html (Scientific Reports 2: 888 (2012))].


Money market fund - Systemic Risk and Regulatory Reform

1 A step along this line has been the creation of the Financial Stability

Oversight Council to address systemic risk issues that have in the

past, as amply illustrated by the money market fund crisis above,

fallen neatly between the cracks of the standing isolated financial

regulators


Money market fund - Systemic Risk and Regulatory Reform

1 A second solution, more focused on money market funds directly, is to re-regulate

them to address the common misunderstandings, and to insure that money market depositors, who enjoy

greater interest rates, thoroughly understand the actual risk they are

undertaking. These risks include substantial interconnectedness between and among money market participants, and various other substantial systemic risks factors.


European Systemic Risk Board

1 It is tasked with the Macroprudential regulation|macro-prudential

oversight of the financial system within the European Union in order to

contribute to the prevention or mitigation of systemic risks to

financial stability in the EU


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