Systemic Risk in the Financial Industry: 'Mimetism' for the Best and for the Worst

19 Pages Posted: 19 Oct 2013

See all articles by Thierry Warin

Thierry Warin

HEC Montreal; CIRANO

Robert E. Prasch

Middlebury College - Department of Economics; Center for Interuniversity Research and Analysis on Organization (CIRANO)

Date Written: October 18, 2013

Abstract

In the wake of the worst financial crisis since 1929, economists are revisiting the received understanding of how financial markets and institutions actually operate. This paper aims to contribute to this reexamination. It builds upon the traditional and widely-accepted mean-variance approach to the processing of information under conditions of risk while reconsidering an inadequately contemplated premise: the actual organization of the financial market. Now, a lot has been said about perverse incentives and contracting arrangements, firms with oligopolistic power, the pricing and market advantages of being too big to fail, and the associated inefficiencies of the regulatory and supervision systems. While we believe that much of that work is valid, we also believe that too little has been done to meld modern portfolio theory (MPT) with insights that can be drawn from recent developments in Industrial Organization. In the model presented here, the MPT finds its place through the "coordination" mechanism, which is the transmission of financial information among agents. The IO perspective finds its place in our model through a variable capturing the fragility of the system: the probability that the quality of information can itself be altered by the system’s "complexity," which in its extreme from can be described as "opacity."

Keywords: systemic risk, specific risk, systematic risk, financial industry, modern portfolio theory, complexity, opacity, Minsky moment, complex systems

JEL Classification: G11, G15, G24, G28

Suggested Citation

Warin, Thierry and Prasch, Robert E., Systemic Risk in the Financial Industry: 'Mimetism' for the Best and for the Worst (October 18, 2013). CIRANO - Scientific Publications 2013s-29. Available at SSRN: https://ssrn.com/abstract=2342250 or http://dx.doi.org/10.2139/ssrn.2342250

Thierry Warin (Contact Author)

HEC Montreal ( email )

3000, Chemin de la Côte-Sainte-Catherine
Montreal, Quebec H2X 2L3
Canada

CIRANO ( email )

2020 rue University, 25th floor
Montreal H3C 3J7, Quebec
Canada

HOME PAGE: http://works.bepress.com/warin/

Robert E. Prasch

Middlebury College - Department of Economics ( email )

Munroe Hall
Middlebury, VT 05753
United States

Center for Interuniversity Research and Analysis on Organization (CIRANO) ( email )

2020 rue University, 25th floor
Montreal H3C 3J7, Quebec
Canada

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