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Any regulation of risk increases risk

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  • Philip Maymin

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  • Zakhar Maymin

    ()

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    Abstract

    We show that any objective risk measurement algorithm mandated by central banks for regulated financial entities will result in more risk being taken by those financial entities than would otherwise be the case. Furthermore, the risks taken by the regulated financial entities are far more systemically concentrated than they would have been otherwise, making the entire financial system more fragile. This result leaves three options for the future of financial regulation: (1) continue regulating by enforcing risk measurement algorithms at the cost of occasional severe crises, (2) regulate more severely and subjectively by fully nationalizing all financial entities, or (3) abolish all central banking regulations, including deposit insurance, thus allowing risk to be determined by the entities themselves and, ultimately, by their depositors through voluntary market transactions, rather than by the taxpayers through enforced government participation. Copyright Swiss Society for Financial Market Research 2012

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    File URL: http://hdl.handle.net/10.1007/s11408-012-0192-3
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    Bibliographic Info

    Article provided by Springer in its journal Financial Markets and Portfolio Management.

    Volume (Year): 26 (2012)
    Issue (Month): 3 (September)
    Pages: 299-313

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    Handle: RePEc:kap:fmktpm:v:26:y:2012:i:3:p:299-313

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    Web page: http://www.springerlink.com/link.asp?id=119763

    Related research

    Keywords: Regulation; Crisis; Risk management; Value-at-risk; Risk; Basel; G18; G21; G28; G38;

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    1. Robert C. Merton, 1980. "On Estimating the Expected Return on the Market: An Exploratory Investigation," NBER Working Papers 0444, National Bureau of Economic Research, Inc.
    2. Brian K. Bucks & Arthur B. Kennickell & Traci L. Mach & Kevin B. Moore, 2009. "Changes in U.S. family finances from 2004 to 2007: evidence from the Survey of Consumer Finances," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.).
    3. Kaplanski, Guy & Levy, Haim, 2007. "Basel's value-at-risk capital requirement regulation: An efficiency analysis," Journal of Banking & Finance, Elsevier, vol. 31(6), pages 1887-1906, June.
    4. Calem, Paul & Rob, Rafael, 1999. "The Impact of Capital-Based Regulation on Bank Risk-Taking," Journal of Financial Intermediation, Elsevier, vol. 8(4), pages 317-352, October.
    5. Ioannidou, V. & Dreu, J. de, 2006. "The Impact of Explicit Deposit Insurance on Market Discipline," Discussion Paper 2006-5, Tilburg University, Center for Economic Research.
    6. Oliver Hermsen, 2010. "The impact of the choice of VaR models on the level of regulatory capital according to Basel II," Quantitative Finance, Taylor & Francis Journals, vol. 10(10), pages 1215-1224.
    7. Anthony Saunders & Ingo Walter, 2012. "Financial architecture, systemic risk, and universal banking," Financial Markets and Portfolio Management, Springer, vol. 26(1), pages 39-59, March.
    8. Nadine Gatzert & Hato Schmeiser, 2011. "On the risk situation of financial conglomerates: does diversification matter?," Financial Markets and Portfolio Management, Springer, vol. 25(1), pages 3-26, March.
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