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Systemic risk in modern financial systems: analytics and policy design

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  • Prasanna Gai
  • Nigel Jenkinson
  • Sujit Kapadia
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    Abstract

    Purpose – In recent years, the financial system has been changing rapidly. At the same time, macroeconomic volatility has fallen in developed countries. The purpose of this paper is to examine how these developments may have affected the nature of systemic crises. The paper also aims to discuss how central banks and other financial regulators might respond to these developments with a clearer, more rigorous, operational framework for their systemic financial stability work. Design/methodology/approach – The paper describes analytical models developed at the Bank of England to assess how recent developments may have affected the probability and potential impact of systemic financial crises. The results from these models help to shape the practical framework for the Bank's financial stability work. Findings – The models suggest that financial innovation and integration, coupled with greater macroeconomic stability, have served to make systemic crises in developed countries less likely than in the past, but potentially more severe. Implementing a practical framework for financial stability work in response to this raises many formidable challenges. Practical implications – If individuals are risk-averse, the recent change in the profile of crises could lower welfare and would suggest that policymakers should place a higher premium on actions to monitor and mitigate systemic risk. The analysis also highlights the importance of differentiating the probability of risks from their potential impact. Originality/value – The paper will be of interest to academics interested in systemic risk, central bankers, financial regulators, and financial market participants.

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    Bibliographic Info

    Article provided by Emerald Group Publishing in its journal Journal of Risk Finance.

    Volume (Year): 8 (2007)
    Issue (Month): 2 (March)
    Pages: 156-165

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    Handle: RePEc:eme:jrfpps:v:8:y:2007:i:2:p:156-165

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    Web page: http://www.emeraldinsight.com

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    Related research

    Keywords: Economic stability; Financial risk;

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    Cited by:
    1. Bretschger, Lucas & Kappel, Vivien & Werner, Therese, 2012. "Market concentration and the likelihood of financial crises," Journal of Banking & Finance, Elsevier, vol. 36(12), pages 3336-3345.
    2. Annika Birch & Tomaso Aste, 2014. "Systemic Losses Due to Counter Party Risk in a Stylized Banking System," Papers 1402.3688, arXiv.org.
    3. Mirakhor, Abbas & Krichene, Noureddine, 2009. "The Recent Crisis: Lessons for Islamic Finance," MPRA Paper 56022, University Library of Munich, Germany.
    4. David Mayes, 2011. "The future of financial markets: financial crisis avoidance," Empirica, Springer, vol. 38(1), pages 77-101, February.
    5. Khaldoun Khashanah & Linyan Miao, 2011. "Dynamic structure of the US financial systems," Studies in Economics and Finance, Emerald Group Publishing, vol. 28(4), pages 321-339, October.

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