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Risk externalities and too big to fail

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  • Taleb, Nassim N.
  • Tapiero, Charles S.

Abstract

This paper establishes the case for a fallacy of economies of scale in large aggregate institutions and the effects of scale risks. The problem of rogue trading and excessive risk taking is taken as a case example. Assuming (conservatively) that a firm exposure and losses are limited to its capital while external losses are unbounded, we establish a condition for a firm not to be allowed to be too big to fail. In such a case, the expected external losses second derivative with respect to the firm capital at risk is positive. Examples and analytical results are obtained based on simplifying assumptions and focusing exclusively on the risk externalities that firms too big to fail can have.

Suggested Citation

  • Taleb, Nassim N. & Tapiero, Charles S., 2010. "Risk externalities and too big to fail," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 389(17), pages 3503-3507.
    • Handle: RePEc:eee:phsmap:v:389:y:2010:i:17:p:3503-3507
    DOI: 10.1016/j.physa.2010.03.014
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    References listed on IDEAS

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    1. Fujiwara, Yoshi, 2004. "Zipf law in firms bankruptcy," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 337(1), pages 219-230.
    2. Taleb, Nassim Nicholas, 2009. "Errors, robustness, and the fourth quadrant," International Journal of Forecasting, Elsevier, vol. 25(4), pages 744-759, October.
    3. Tapiero, Charles S., 2007. "Consumers risk and quality control in a collaborative supply chain," European Journal of Operational Research, Elsevier, vol. 182(2), pages 683-694, October.
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    5. Saito, Yukiko Umeno & Watanabe, Tsutomu & Iwamura, Mitsuru, 2007. "Do larger firms have more interfirm relationships?," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 383(1), pages 158-163.
    6. Konstantin Kogan & Charles S. Tapiero, 2007. "Supply Chain Games: Operations Management And Risk Valuation," International Series in Operations Research and Management Science, Springer, number 978-0-387-72776-9, September.
    7. Aleksiejuk, Agata & Hołyst, Janusz A., 2001. "A simple model of bank bankruptcies," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 299(1), pages 198-204.
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    Cited by:

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    2. Torsten Heinrich & Henning Schwardt, 2013. "Institutional Inertia and Institutional Change in an Expanding Normal-Form Game," Games, MDPI, vol. 4(3), pages 1-28, August.

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