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• 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
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Hedge funds - Systemic risk
1 These systemic risk concerns are exacerbated by the prominent role of hedge funds in the financial markets
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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
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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
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Systemic risk - Explanation
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.
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Systemic risk - Explanation
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.
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Systemic risk - Explanation
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)
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Systemic risk - Explanation
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/$file/PCI_Systemic_Risk_Definition.pdf Systemic
Risk], Property Casualty Insurers Association of America
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Systemic risk - Explanation
1 A general definition of Systemic Risk which is not limited by its mathematical approaches,
model assumptions or focus on one institution; and which is also the first
operationalizable definition of Systemic Risk encompassing the systemic character of
financial, political, environmental, and many other risks is available since
2010.[http://ssrn.com/abstract=1620495 Market Dynamics Systemic Risk], Milan
Boran
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Systemic risk - TBTF/TICTF
1 The impact is also dependent on how correlated an institution's
business is with other systemic risks.[http://www.pciaa.net/web/sitehome.nsf/lcpublic/392/$file/PCI_Systemic_Ri
sk_Definition.pdf PCI Definition of Systemic Risk]
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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
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Systemic risk - SRISK
1 Volatility, correlation and tails for systemic risk measurement,
[http://ssrn.com/abstract=1611229] build a systemic risk measure named
SRISK
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Systemic risk - SRISK
1 Systemic Risk in Europe] allows for various factors, time varying
parameters, and is therefore more adapted to the European market
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Systemic risk - SRISK
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.
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Systemic risk - Factors
1 Factors that are found to support
systemic risks are:
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Systemic risk - Factors
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
Systemic risk - Factors
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.
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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.
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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]
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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.
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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]
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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]
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Systemic risk - Systemic risk and insurance
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:
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Systemic risk - Systemic risk and insurance
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:
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Systemic risk - Systemic risk and insurance
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]
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Systemic risk - Systemic risk and insurance
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.
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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]
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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.
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Systemic risk - Further reading
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.
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Systemic risk - Further reading
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).
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Systemic risk - Further reading
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))].
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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
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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.
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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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