Skip to main content

Systemic risk and financial regulations: A theoretical perspective

Journal of Banking Regulation volume 17, pages 188–199 (2016)Cite this article

Abstract

This article inserts the notion of systemic risk into the theoretical foundations of modern finance. By systemic risk, we mean risks because of interdependence among leading firms, in other words complexity. It builds upon the traditional mean-variance approach while reconsidering an inadequately contemplated source of risk: the actual organization of the financial market. As such, we take seriously the idea that some oligopolistic firms may be understood by market participants to be central to the fabric of modern financial markets, and in that sense can be deemed too big to fail. While we believe that much of traditional financial analysis is valid in its own terms, we also believe that important insights can be acquired from melding Modern Portfolio Theory with recent developments in Industrial Organization.

This is a preview of subscription content, access via your institution.

Access options

Buy single article

Instant access to the full article PDF.

USD 39.95

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Figure 1
Figure 2

References and Notes

  • Borio, C. (2013) The great financial crisis: Setting priorities for new statistics. Journal of Banking Regulation 14 (3): 306–317.

    Article  Google Scholar 

  • Glasser, T.D. (2013) Leveraging data for financial stability monitoring. Journal of Banking Regulation 14 (3): 195–208.

    Article  Google Scholar 

  • Fisher, R.W. (2013) Ending ‘too big to fail’: A proposal for reform before it’s too late. federal reserve bank of dallas, 16 January, http://www.dallasfed.org/news/speeches/fisher/2013/fs130116.cfm, accessed 20 February 2015.

  • Willet, T.D. (2012) The role of defective mental models in generating the global financial crisis. Journal of Financial Economic Policy 4 (1): 41–57.

    Article  Google Scholar 

  • Moosa, I. (2010) The myth of too big to fail. Journal of Banking Regulation 11 (4): 319–333.

    Article  Google Scholar 

  • Cohan, W.D. (2009) House of Cards: A Tale of Hubris and Wretched Excess on Wall Street. New York: Doubleday.

    Google Scholar 

  • Eggertsson, G.B. and Krugman, P. (2012) Debt, deleveraging, and the liquidity trap: A Fisher-Minsky-Koo Approach*. The Quarterly Journal of Economics 127 (3): 1469–1513.

    Article  Google Scholar 

  • Kindleberger, C.P. and Aliber, R.Z. (2011) Manias, Panics and Crashes: A History of Financial Crises, 6th edn. London: Palgrave Macmillan.

    Google Scholar 

  • Minsky, H.P. (1986) Stabilizing an Unstable Economy. New Haven, CT: Yale University Press.

    Google Scholar 

  • Minsky, H.P. (1977) The financial instability hypothesis: An interpretation of Keynes and an alternative to ‘standard’ theory. Challenge 20 (1): 20–27.

    Article  Google Scholar 

  • Mirowski, P. (2010) Inherent vice: Minsky, Markomata, and the tendency of markets to undermine themselves. Journal of Institutional Economics 6 (4): 415–443.

    Article  Google Scholar 

  • Lamfalussy, A. (2004) Central Banks and Financial Stability. Speech to 2nd Pierre Werner Lecture. Luxembourg: Banque Centrale du Luxembourg.

    Google Scholar 

  • Prasch, R. and Warin, T. (2012) Moral Hazard and the mounting of a crisis: A U.S. Narrative. International Journal of Applied Business and Economic Research 10 (1): 177–187.

    Google Scholar 

  • Whitehead, C.K. (2010) Reframing financial regulation. Journal of Financial Transformation 29: 57–69.

    Google Scholar 

  • Arestis, P and Basu, S. (2004) Financial globalization and regulation. Research in Internaitonal Business and Finance 18 (2): 129–140.

    Article  Google Scholar 

  • Peretz, P. and Schroedel, J.R. (2009) Financial regulation in the United States: Lessons from history. Public Administration Review 69 (4): 603–612.

    Article  Google Scholar 

  • Davies, H. (2008) International Financial Regulation : The Quiet Revolution [Internet]. eSocialSciences; 2008 [cited 7 February 2012]. Report No.: 1725, http://www.esocialsciences.org/Download/repecDownload.aspx?fname=Document114102008520.203747.pdf&fcategory=Articles&AId=1725&fref=repec, accessed 20 February 2015.

  • Couppey-Soubeyran, J. (2010) Financial regulation in the Crisis regulation, market discipline, internal control: The big three in turmoil. International Economics 123 (3): 13–30.

    Article  Google Scholar 

  • Marjit, S. (2003) Monitoring success: On a fundamental principle of financial regulation. Economic and Political Weekly 38 (19): 1871–1873.

    Google Scholar 

  • Pan, EJ. (2009) Structural reform of financial regulation. SSRN Electronic Journal (250): 1–66, advance online publication 27 January, http://dx.doi.org/10.2139/ssrn.1333385.

  • Warin, T and Fourçans, A. (2006) Tax competition and information sharing in Europe: A signaling game. Middlebury College, Middlebury, USA. Report No.: 0605, http://ideas.repec.org/p/mdl/mdlpap/0605.html.

  • Whalen, CJ. (2001) Integrating Schumpeter and Keynes: Hyman Minsky’s theory of capitalist development. Journal of Economic Issues 35 (4): 805–823.

    Article  Google Scholar 

  • Yener, C. (2011) Financial engineering and engineering of financial regulation. University Library of Munich, Germany, Report No.: 34838, Middlebury (VT, USA), http://mpra.ub.uni-muenchen.de/34838/.

  • Markowitz, H. (1952) Portfolio selection. The Journal of Finance 7 (1): 77–91.

    Google Scholar 

  • Sharpe, WF. (1963) A simplified model for portfolio analysis. Management Science 9 (2): 277–293.

    Article  Google Scholar 

  • Lintner, J. (1965) The valuation of risk assets and the selection of risky investments in stock portfolios and capital budgets. The Review of Economics and Statistics 47 (1): 13–37.

    Article  Google Scholar 

  • Mossin, J. (1966) Equilibrium in a capital asset market. Econometrica 34 (4): 768–783.

    Article  Google Scholar 

  • Portait, R. and Poncet, P. (2009) Finance de marché. 2eme ed. Paris, France: Dalloz.

    Google Scholar 

  • Wagner, WH. and Lau, SC. (1971) The effect of diversification on risk. Financial Analysts Journal 27 (6): 48–53.

    Article  Google Scholar 

  • Fujii, M. (2010) Securitized products, financial regulation, and systemic risk. East Asian bureau of economic research. Report No.: 23010, Tokyo, http://www.eaber.org/node/23010.

  • Marcelo, A., Rodríguez, A. and Trucharte, C. (2008) Stress tests and their contribution to financial stability. Journal of Banking Regulation 9 (2): 65–81.

    Article  Google Scholar 

  • Markose, SM. (2013) Systemic risk analytis: A data-driven multi-agent financial network (MAFN) approach. Journal of Banking Regulation 14 (3): 285–305.

    Article  Google Scholar 

  • Vasudev, PM. (2014) Credit derivatives and the dodd-frank act: Is the regulatory response appropriate? Journal of Banking Regulation 15 (1): 56–74.

    Article  Google Scholar 

  • To simplify, we assume the average return of the market portfolio is 0.

  • Knight, F. (1929) Risk, Uncertainty and Profit. Hart, Schaffner et Marx. Cambridge: Boston, MA: Houghton Mifflin Company.

    Google Scholar 

  • Smith, A. (1977/1776) An Inquiry into the Nature and Causes of the Wealth of Nations. Chicago, IL: University of Chicago Press.

    Book  Google Scholar 

Download references

Acknowledgements

Vice-President at CIRANO (Canada). The authors would like to thank Cirano (Canada). The usual caveats apply.

Author information

Authors and Affiliations

  1. Department of International Business, HEC Montreal, 3000, chemin de la Côte-Sainte-Catherine, Montréal (Québec), H3T 2A7, Canada

    Thierry Warin

Authors
  1. Robert Prasch
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. Thierry Warin
    View author publications

    You can also search for this author in PubMed Google Scholar

Additional information

1was professor of Economics at Middlebury College (USA). He received his PhD in economics from the University of California, Berkeley in 1992. He was a past President of the Association for Evolutionary Economics, and was on the Board of Directors for the Association for Social Economics. As well, he served on the Board of Editors of the Journal of Economic Issues and the Review of Political Economy, and was an Associate Fellow at CIRANO.

2interests include financial regulations, open macroeconomics and regional economics. He is Associate Professor of International Business at HEC Montréal (Canada). He held positions in several academic institutions (Middlebury College, USA; Polytechnique Montreal; Sun Yat Sen University, Guangzhou; Essec Business School, Paris; HEC Paris; UIBE, Beijing).

Rights and permissions

Reprints and Permissions

About this article

Verify currency and authenticity via CrossMark

Cite this article

Prasch, R., Warin, T. Systemic risk and financial regulations: A theoretical perspective. J Bank Regul 17, 188–199 (2016). https://doi.org/10.1057/jbr.2015.4

Download citation

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1057/jbr.2015.4

Keywords

  • systemic risk
  • specific risk
  • systematic risk
  • modern portfolio theory
  • complexity
  • financial regulations