The Policy Conundrum of Financial Market Complexity

Abstract

The first global financial sector crash eludes conventional assessments of sector risk. Singling out the usual culprits-the housing bubble, executive pay, regulators, rating agencies, risk models, and global imbalances-fails to explain either the unpredictability or the rapidity of the collapse of 2008, which in many ways resembled the avalanche of a sand pile, where at some point of criticality, avalanches occur that bear no relationship to the grain of sand that triggered them. Since appropriate financial regulation is part of the remedy, policymakers should recognize that success will depend on a more refined knowledge of why some initial events may have prompted an avalanche, while others did not.