Too Big to Fail, Hidden Risks, and the Fallacy of Large Institutions
Charles S. Tapiero
NYU Polytechnic School of Engineering - Department of Finance and Risk Engineering
Nassim Nicholas Taleb
NYU-Tandon School of Engineering; New England Complex Systems Institute
May 2, 2009
Large institutions are disproportionately more fragile to Black Swans.
This paper establishes the case for a fallacy of economies of scale in large aggregate institutions. The problem of rogue trading is taken as a case example of hidden risks where rogue traders and losses are considered independently and dependently of the institution’s size. Both independent and dependent loss and hidden positions are shown to lead to the paper’s conclusion, that size and economies of scale have commensurate risks that mitigate the advantages of size.
Keywords: economies of scale, banking crisis, risk management, operational risk
JEL Classification: D8, G11, G12, G13, N00
Date posted: May 5, 2009