Table of Contents

Managing Risk in the Financial System

Managing Risk in the Financial System

Edited by John Raymond LaBrosse, Rodrigo Olivares-Caminal and Dalvinder Singh

Managing Risk in the Financial System makes important and timely contributions to our knowledge and understanding of banking law, financial institution restructuring and related considerations, through the production of an innovative, international and interdisciplinary set of contributions which link together the law and policy issues surrounding systemic risk and crisis management.

Chapter 6: Systemic Contingent Claim Analysis – A Model Approach to Systemic Risk

Dale F. Gray and Andreas A. Jobst

Subjects: economics and finance, financial economics and regulation, money and banking, law - academic, finance and banking law

Extract

Dale F. Gray and Andreas A. Jobst1 6.1. INTRODUCTION Since 2008 unprecedented and sweeping crisis interventions have arrested a market panic, effectively stabilized the global financial system, and helped shore up investor confidence. In spite of this positive development, the encouraging picture has been tainted by mounting concerns surrounding the fiscal positions of sovereigns that have borrowed excessively to stabilize their financial systems and the related potential for contagion across the most vulnerable countries. Support measures provided to large financial institutions have resulted in considerable risk transfer to the government, which has intensified concerns about overall long-term fiscal sustainability as a swift recovery of the financial sector remains uncertain.2 Moreover, the unresolved moral hazard problem of large complex financial institutions (LCFIs) that are deemed ‘too-important’ or ‘toonetworked’ to fail, continues to imply large contingent liabilities for the public sector. Such contingent liabilities may imperil fiscal sustainability as they increase the susceptibility of public finances to the potential impact of systemic distress in the financial sector. Given the elusive nature of systemic financial risk3 from these contingent liabilities, policy-makers recognize the need for a multi-faceted approach comprising complementary measures in areas of regulatory policies, supervisory scope, and resolution arrangements as part of a sustainable solution towards a more resilient financial sector. Current policy efforts are aimed at establishing a regulatory framework that helps mitigate systemic risk from linkages between institutions and the extent to which they amplify incentive conflicts and coordination failure in various segments of financial markets. Some measures under...

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