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E-MailThis paper comes to us from Iman Anabtawi, Professor of Law at the UCLA School of Law, and Steven L. Schwarcz, the Stanley A. Star Professor of Law & Business at the Duke University School of Law.
Our paper, Regulating Systemic Risk: Towards an Analytical Framework, forthcoming in the Notre Dame Law Review, attempts to construct an analytical framework that both captures the systemic transmission of economic shocks and explains the behavioral and other market failures that justify regulatory intervention.
The paper starts by describing two otherwise independent correlations that can combine to potentiate the transmission of localized economic shocks into broader systemic crises. The first of these is a correlation between low-probability risk and firm financial integrity; the second is a correlation among financial firms and markets.
We use four financial crises, including the recent global financial crisis, to illustrate these correlations and their potential to combine. Although a complete historical study of financial crises might indicate additional correlations, we argue that the ability of the combination of these two correlations to potentiate the transmission of economic shocks makes them worthy of study even if other correlations exist.
We show that a series of interrelated behavioral and other market failures makes it unlikely that financial market participants will, without regulatory intervention, use sufficient effort in identifying these correlations or in attempting to prevent from combining. Regulatory intervention is therefore needed, we argue, to address these behavioral and other market failures.
The full paper is available for download here.
