Has Finance Made the World Riskier?

Abstract

"Developments in the financial sector have led to an expansion in its ability to spread risks. The increase in the risk bearing capacity of economies, as well as in actual risk taking, has led to a range of financial transactions that hitherto were not possible, and has created much greater access to finance for firms and households. On net, this has made the world much better off. Concurrently, however, we have also seen the emergence of a whole range of intermediaries, whose size and appetite for risk may expand over the cycle. Not only can these intermediaries accentuate real fluctuations, they can also leave themselves exposed to certain small probability risks that their own collective behaviour makes more likely. As a result, under some conditions, economies may be more exposed to financial-sector-induced turmoil than in the past. The paper discusses the implications for monetary policy and prudential supervision. In particular, it suggests market-friendly policies that would reduce the incentive of intermediary managers to take excessive risk." Copyright 2006 The Author Journal compilation (c) 2006 Blackwell Publishing Ltd.

Econometric measures of connectedness and systemic risk in the finance and insurance sectors

“…Our approach is to simply measure correlation directly and unconditionally-through Gray (2009), Rajan (2006, Danielsson, Shin, and Zigrand (2011), and Reinhart and Rogoff (2009). principal components analysis and by pairwise Granger-causality tests-and use these metrics to gauge the degree of connectedness of the financial system. During normal times, such connectivity may be lower than during periods of distress, but by focusing on unconditional measures of connectedness, we are able to detect new linkages between parts of the financial system that have nothing to do with simultaneous losses.…”

'When the Cat's Away the Mice Will Play': Does Regulation at Home Affect Bank Risk Taking Abroad?

“…For example, international banks may have an incentive to relegate their riskier activities to their foreign subsidiaries (i.e., the bank's "periphery") to which they limit their exposure (Powell and Majnoni, 2007). In that sense, risky behavior abroad could re ‡ect a "search for yield" (Rajan, 2006;Goldberg, 2009). Another possibility is that stricter regulation leads to more risky behavior both in domestic and in foreign markets.…”

Risk, Uncertainty and Monetary Policy

“…The Federal Reserve's pattern of providing liquidity to financial markets following market tensions, which became known as the "Greenspan put," has been cited as one of the contributing factors to the build-up of a speculative bubble prior to the 2007-09 financial crisis. 1 Whereas some rather informal stories have linked monetary policy to risk-taking in financial markets (Rajan (2006), Adrian and Shin (2008), Borio and Zhu (2008)), it is fair to say that no extant research establishes a firm empirical link between monetary policy and risk aversion in asset markets. 2 Second, Bloom (2009) and Bloom, Floetotto and Jaimovich (2009) show that heightened "economic uncertainty" decreases employment and output.…”