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Systemic Risk in the Financial Industry: “Mimetism” for the Best and for the Worst

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  • Thierry Warin

    ()

  • Robert E. Prasch

Abstract

In the wake of the worst financial crisis since 1929, economists are revisiting the received understanding of how financial markets and institutions actually operate. This paper aims to contribute to this reexamination. It builds upon the traditional and widely-accepted mean-variance approach to the processing of information under conditions of risk while reconsidering an inadequately contemplated premise: the actual organization of the financial market. Now, a lot has been said about perverse incentives and contracting arrangements, firms with oligopolistic power, the pricing and market advantages of being too big to fail, and the associated inefficiencies of the regulatory and supervision systems. While we believe that much of that work is valid, we also believe that too little has been done to meld modern portfolio theory (MPT) with insights that can be drawn from recent developments in Industrial Organization. In the model presented here, the MPT finds its place through the "coordination" mechanism, which is the transmission of financial information among agents. The IO perspective finds its place in our model through a variable capturing the fragility of the system: the probability that the quality of information can itself be altered by the system’s "complexity," which in its extreme from can be described as "opacity."

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Bibliographic Info

Paper provided by CIRANO in its series CIRANO Working Papers with number 2013s-29.

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Date of creation: 01 Aug 2013
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Handle: RePEc:cir:cirwor:2013s-29

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Keywords: systemic risk; specific risk; systematic risk; financial industry; modern portfolio theory; complexity; opacity; Minsky moment; complex systems;

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  1. Thierry Warin & André Fourçans, 2006. "Tax Competition and Information Sharing in Europe: A Signaling Game," Middlebury College Working Paper Series 0605, Middlebury College, Department of Economics.
  2. Coskun, Yener, 2011. "Financial Engineering and Engineering of Financial Regulation," MPRA Paper 34838, University Library of Munich, Germany.
  3. Whitehead, Charles, 2010. "Reframing Financial Regulation," Journal of Financial Transformation, Capco Institute, vol. 29, pages 57-69.
  4. Arestis, Philip & Basu, Santonu, 2004. "Financial globalisation and regulation," Research in International Business and Finance, Elsevier, vol. 18(2), pages 129-140, June.
  5. Robert E. Prasch & Thierry Warin, 2012. "Moral Hazard and the Mounting of a Crisis: A U.S. Narrative," CIRANO For discussion... 2012dt-03, CIRANO.
  6. Thierry Warin & Andrew Blakely, 2009. "Choice or Mimetism in the Decision to Migrate? A European Illustration," CIRANO Working Papers 2009s-38, CIRANO.
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