Thoughts on financial derivatives, systematic risk, and central banking: a review of some recent developments
AbstractThis paper critically reviews the literature examining the role of central banks in addressing systemic risk. We focus on how the growth in derivatives markets might affect that role. Analysis of systemic risk policy is hampered by the lack of a consensus theory of systemic risk. We propose a set of criteria that theories of systemic risk should satisfy, and we critically discuss a number of theories proposed in the literature. We argue that concerns about systemic effects of derivatives appear somewhat overstated. In particular, derivative markets do not appear unduly prone to systemic disturbances. Furthermore, derivative trading may increase informational efficiency of financial markets and provide instruments for more effective risk management. Both of these effects tend to reduce the danger of systemic crises. However, the complexity of derivative contracts (in particular, their high implicit leverage and nonlinear payoffs) do complicate the process of regulatory oversight. In addition, derivatives may make the conduct of monetary policy more difficult. Most theories of systemic risk imply a critical role for central banks as the ultimate provider of liquidity. However, the countervailing danger of moral hazard must be recognized and addressed through vigilant supervision.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Federal Reserve Bank of Chicago in its series Working Paper Series with number WP-99-20.
Date of creation: 1999
Date of revision:
Contact details of provider:
Postal: P.O. Box 834, 230 South LaSalle Street, Chicago, Illinois 60690-0834
Web page: http://www.chicagofed.org/
More information through EDIRC
This paper has been announced in the following NEP Reports:
- NEP-ALL-2000-01-31 (All new papers)
- NEP-FIN-2000-01-31 (Finance)
- NEP-HIS-2000-01-31 (Business, Economic & Financial History)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Flannery, Mark J, 1994.
"Debt Maturity and the Deadweight Cost of Leverage: Optimally Financing Banking Firms,"
American Economic Review,
American Economic Association, vol. 84(1), pages 320-31, March.
- Mark J. Flannery, 1991. "Debt maturity and the deadweight cost of leverage: optimally financing banking firms," Proceedings, Federal Reserve Bank of San Francisco, issue Nov.
- Martin Feldstein, 1991. "The Risk of Economic Crisis," NBER Books, National Bureau of Economic Research, Inc, number feld91-2, September.
- Robert A. Eisenbeis, 1997. "Bank deposits and credit as sources of systemic risk," Economic Review, Federal Reserve Bank of Atlanta, issue Q 3, pages 4-19.
- Chang, R. & Velasco, A., 1999.
"Liquidity Crises in Emerging Markets: Theory and Policy,"
99-14, C.V. Starr Center for Applied Economics, New York University.
- Roberto Chang & Andrés Velasco, 2000. "Liquidity Crises in Emerging Markets: Theory and Policy," NBER Chapters, in: NBER Macroeconomics Annual 1999, Volume 14, pages 11-78 National Bureau of Economic Research, Inc.
- Roberto Chang & Andres Velasco, 1999. "Liquidity Crises in Emerging Markets: Theory and Policy," NBER Working Papers 7272, National Bureau of Economic Research, Inc.
- Roberto Chang & Andrés Velasco, 1999. "Liquidity Crises in Emerging Markets: Theory and Policy," Documentos de Trabajo 59, Centro de Economía Aplicada, Universidad de Chile.
- Roberto Chang & Andres Velasco, 1999. "Liquidity crises in emerging markets: Theory and policy," Working Paper 99-15, Federal Reserve Bank of Atlanta.
- Stephen D. Smith & Larry D. Wall, 1992. "Financial panics, bank failures, and the role of regulatory policy," Economic Review, Federal Reserve Bank of Atlanta, issue Jan, pages 1-11.
- David Marshall, 1998. "Understanding the Asian crisis: systemic risk as coordination failure," Economic Perspectives, Federal Reserve Bank of Chicago, issue Q III, pages 13-38.
- V.V. Chari, 1989. "Banking without deposit insurance or bank panics: lessons from a model of the U.S. national banking system," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Sum, pages 3-19.
- Eichengreen, Barry & Portes, Richard, 1986.
"The Anatomy of Financial Crises,"
CEPR Discussion Papers
130, C.E.P.R. Discussion Papers.
- Michael D. Bordo, 1990. "The lender of last resort : alternative views and historical experience," Economic Review, Federal Reserve Bank of Richmond, issue Jan, pages 18-29.
- Charles W. Calomiris & Gary Gorton, .
"The Origins of Banking Panics: Models, Facts, and Bank Regulation,"
Rodney L. White Center for Financial Research Working Papers
11-90, Wharton School Rodney L. White Center for Financial Research.
- Charles W. Calomiris & Gary Gorton, 1991. "The Origins of Banking Panics: Models, Facts, and Bank Regulation," NBER Chapters, in: Financial Markets and Financial Crises, pages 109-174 National Bureau of Economic Research, Inc.
- Hyman P. Minsky, 1992. "The Financial Instability Hypothesis," Economics Working Paper Archive wp_74, Levy Economics Institute, The.
- Smith, Bruce D, 1991. "Bank Panics, Suspensions, and Geography: Some Notes on the "Contagion of Fear" in Banking," Economic Inquiry, Western Economic Association International, vol. 29(2), pages 230-48, April.
- A. W. Coats, 1995. "Comment," History of Political Economy, Duke University Press, vol. 27(5), pages 157-161, Supplemen.
- Kanatas, George, 1986. " Deposit Insurance and the Discount Window: Pricing under Asymmetric Information," Journal of Finance, American Finance Association, vol. 41(2), pages 437-50, June.
- Steven Radelet & Jeffrey Sachs, 1998. "The Onset of the East Asian Financial Crisis," NBER Working Papers 6680, National Bureau of Economic Research, Inc.
- Hentschel, Ludger & Smith, Clifford Jr., 1997. "Derivatives regulation: Implications for central banks," Journal of Monetary Economics, Elsevier, vol. 40(2), pages 305-346, October.
- Davis, E. Philip, 1995. "Debt, Financial Fragility, and Systemic Risk," OUP Catalogue, Oxford University Press, number 9780198233312.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Bernie Flores).
If references are entirely missing, you can add them using this form.