A Systems Accident Approach to Systemic Financial Risk

Abstract:     
This paper proposes a definition and assessment methodology for systemic financial risk that was inspired by systems accident research. Sociologist Charles Perrow found that industrial, aviation and marine systems are prone to failure if those systems are interactively complex and tightly coupled. Using that framework as a starting point, financial crisis research led to the definition of systemic financial risk as a function of financial complexity and excessive leverage. I present practical criteria for applying these parameters, and then profile the triggering mechanism of systemic financial risk - -financial contagion -- in a behavioral context consistent with my framework. A discussion of the current state of systemic financial risk is then offered. By practically defining systemic financial risk in the context of financial crisis case histories (with a focus on contemporary history) this paper facilitates a deeper and more practical understanding of this important, yet seemingly elusive phenomenon. And it does so in a manner readily assessable to a broad array of financial agents and researchers.

Number of Pages in PDF File: 29

Keywords: Systemic risk, systems accident, financial complexity, excessive leverage, financial contagion

JEL Classification: E19, G15, G20

Accepted Paper Series