Financial Markets and Portfolio Management

, Volume 26, Issue 3, pp 299–313

Any regulation of risk increases risk

Article
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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.

Keywords

Regulation Crisis Risk management Value-at-risk Risk Basel 

JEL Classification

G18 G21 G28 G38 

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Copyright information

© Swiss Society for Financial Market Research 2012

Authors and Affiliations

  1. 1.Department of Finance and Risk Engineering, Six MetroTech CenterNYU-Polytechnic InstituteBrooklynUSA
  2. 2.Quantitative Investment Services, Inc.GreenwichUSA

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