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Understanding Systemic Risk in Global Financial Markets. Wiley Finance

  • ID: 4331334
  • Book
  • August 2017
  • Region: Global
  • 272 Pages
  • John Wiley and Sons Ltd
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Praise for Understanding Systemic Risk in Global Financial Markets

"Global financial crisis has brought to the fore serious lacunae in the approach to regulation and supervision of systemic risk. This book traces the evolution of financial sectors grappling with different kinds of systemic risks, providing analytical insights of events surrounding the global financial crisis, identifying early warning indicators, and emphasizing the criticality of data towards effective monitoring and management of systemic financial risks through both macro and micro prudential regulations. The book is a valuable addition to existing literature and would be very useful for the students, academics, regulators, and professionals of Economics, Finance, and Management Studies."
—Viral V. Acharya, Deputy Governor, Reserve Bank of India

"This book provides the perfect mix of historic warnings and current regulatory requirements necessary to maintain a functioning modern global financial system."
—Chris Meyers, Director of Education, Museum of American Finance

"A valuable resource that brings together both detailed reviews of individual topics essential to an understanding of systemic risk regulation and unique insights on the relationships between them."
—Peter Curley, Promontory Financial Group

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Preface xiii

Acknowledgments xvii

About the Authors xviii


Introduction to Systemic Risk 1

What Is Systemic Risk? 2

Systemic Risk Drivers 3

Why Systemic Risk Must Be Understood, Monitored, and Managed 5


How We Got Here: A History of Financial Crises 9

Common Drivers of Historical Crises 10

Bursting of Asset Bubbles 10

Banking Crises 14

Sovereign Debt Crisis 15

International Contagion 18


The Credit Crisis of 2007–2009 24

Planting the Seeds of a Bubble: The Early 2000s 25

Wall Street’s Role 27

The U.S. Government Takeover of the GSEs 30

The Tipping Point: Lehman Brothers’ Failure 32

Aftermath of the Credit Crisis 35

Cost of Government Bailouts 37


Systemic Risk, Economic and Behavioral Theories: What Can We Learn? 44

Minsky Three–Part Model 45

Debt Deflation Cycle 46

Benign Neglect 47

Behavioral Theories 48

Risk Aversion Bias 49

Asset Prices 50

Homogeneous Expectations versus Heterogeneity 51

Anchoring Heuristic 52

Excessive Optimism 52

Familiarity Bias 53

Fallacy of Composition 53

Fight or Flight 53


Systemic Risk Data 59

Key Data Attributes 60

Key Policy Changes to Address Data Gaps 60

Data Sources 63

Data Collection Challenges and Remaining Gaps 63

Move Toward Standardization: Legal Entity Identifier Initiative 68


Macroprudential versus Microprudential Oversight 73

A Comparison of Macroprudential versus Microprudential 74

Microprudential Policies 74

Macroprudential Policies 76

A Historical Perspective on Macroprudential Tools 77

Choice of Macroprudential Policy Tools 79


Introduction to the U.S. Regulatory Regime 84

Who Are the Regulators? 84

U.S. Regulatory Approaches 86

Comparison of U.S. versus International Financial Regulatory Regimes 87

Introduction to the Dodd–Frank Act 90


Introduction to International Regulatory Regimes 97

The Financial Stability Board 97

The Basel Accords 99

The European Systemic Risk Board 99

Principles for Financial Market Infrastructures 102


Systemically Important Entities 107

Introduction to Systemically Important Entities 107

Classification of Entities as Systemically Important by the FSOC 108

Bank SIFIs 110

Nonbank SIFIs 110

SIFMUs 112

Globally Systemically Important Banks 112

Total Loss–Absorbing Capacity (TLAC) Requirements 114

Broad Impact of Financial Stability Requirements 117


The Volcker Rule 120

Introduction to the Volcker Rule 120

The Volcker Rule: Details 122

Prohibition of Proprietary Trading 123

Prohibition of Ownership or Sponsorship of Hedge Funds and Private Equity Funds 123

The Volcker Rule and Systemically Risky Nonbank Financial Companies 123

Activities That Are Permitted Despite the Volcker Rule 124

Implementation of the Volcker Rule 125

Volcker Rule: Criticism 126


Counterparty Credit Risk 130

Overview of Derivative Securities 130

Counterparty Exposure 133

How Counterparty Credit Risk Is Managed 136

Collateral 136

Netting 136

Central Counterparties 139

Counterparty Credit Risk and Systemic Risk 142


The Dodd–Frank Act and Counterparty Credit Risk 147

Measuring Counterparty Exposure in the OTC Derivatives Market 147

Overview of Historical Data 149

The Evolution of the U.S. Regulatory Approach toward OTC Derivatives 152

Key Provisions of Title VII of the Dodd–Frank Act 153

Mandatory Clearing 154

Execution Platforms and Data Repositories 154

Registration Requirements 155

The Push–Out Rule 155

The End User Exemption 155

Criticism of Title VII of the Dodd–Frank Act 155


The Basel Accords 159

What Are the Basel Accords? 159

The Approach of the Basel Accords 160

Basel I 161

Basel II 163

Pillar 1: Minimum Capital Requirements 163

Pillar 2: Supervisory Review 164

Pillar 3: Market Discipline 165

Basel II.5 165

Basel III 165

The Continuing Evolution of the Basel Accords 166


Lender of Last Resort 169

Lender of Last Resort Concept 169

Henry Thornton, Walter Bagehot, and Alternative Views 170

The Fed’s Role in the Great Depression 172

The Credit Crisis of 2007–2009 173


Interconnectedness Risk 177

A Case Study of Interconnectedness 178

Interconnectedness Categories 179

The Depository Trust & Clearing Corporation 180

Post–Crisis Regulatory View of Interconnectedness 181

Basel Committee on Banking Supervision 181

Office of Financial Research 182

CPMI IOSCO Principles 184

An Approach to Analyzing Interconnectedness Risk 185

The Depository Trust & Clearing Corporation 185


Conclusion: Looking Ahead 190

It’s Not a Question of If, but When, Where, and How 192

A Summary of Global Surveys 192

Sources of Systemic Risk 193

Preparing for the Next Crisis 194

Appendix: Systemic Risk Models 198

Structural versus Reduced–Form Credit Models 198

Contingent Claims and Default Models 199

Merton versus Garch 204

Studies in Support of Merton 205

Macroeconomic Measures 210

Probability Distribution Measures 211

Illiquidity Measures 214

Counterparty Risk Measures 215

Behavioral Models 217

Solutions to the Knowledge Check Questions 223

Index 239

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Aron Gottesman
Michael Leibrock
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