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Risk Management with Interdependent Choice

  • Morris, Stephen
  • Shin, Hyun Song

Risks faced by traders from price movements are sometimes magnified by the actions of other traders. Risk-management systems which neglect this feature may give a seriously misleading picture of the true risks. The hazards arising from this potential blindspot are at their most dangerous when the prevailing conventional wisdom lulls traders into a false sense of security on the attractiveness of a trading position. The efforts of one trader to reverse his trade makes more acute the need to follow suit on the part of others. For markets dominated by traders with short time horizons, such interdependence leads to exaggerated price movements. Estimates of "value at risk" which recognize such interdependence of actions can diverge substantially from those given by conventional techniques. Copyright 1999 by Oxford University Press.

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Article provided by Oxford University Press in its journal Oxford Review of Economic Policy.

Volume (Year): 15 (1999)
Issue (Month): 3 (Autumn)
Pages: 52-62

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Handle: RePEc:oup:oxford:v:15:y:1999:i:3:p:52-62
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  1. Morris, S & Song Shin, H, 1996. "Unique Equilibrium in a Model of Self-Fulfilling Currency Attacks," Economics Papers 126, Economics Group, Nuffield College, University of Oxford.
  2. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, June.
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