Working paper
Thoughts on Financial Derivatives, Systematic Risk, and Central Banking: A Review of Some Recent Developments
Working paper series (Federal Reserve Bank of Chicago), Vol.WP 99-20
Federal Reserve Bank of Chicago
12/1999
Abstract
This paper critically reviews the literature examining the role of central banks in addressing systemic risk. The authors focus on how the growth in derivatives markets might affect that role. Analysis of systemic risk policy is hampered by the lack of a consensus theory of systemic risk. They propose a set of criteria that theories of systemic risk should satisfy, and they critically discuss a number of theories proposed in the literature. They argue that concerns about systemic effects of derivatives appear somewhat overstated. In particular, derivative markets do not appear unduly prone to systemic disturbances. Furthermore, derivative trading may increase informational efficiency of financial markets and provide instruments for more effective risk management. Both of these effects tend to reduce the danger of systemic crises. However, the complexity of derivative contracts (in particular, their high implicit leverage and nonlinear payoffs) do complicate the process of regulatory oversight. In addition, derivatives may make the conduct of monetary policy more difficult. Most theories of systemic risk imply a critical role for central banks as the ultimate provider of liquidity. However, the countervailing danger of moral hazard must be recognized and addressed through vigilant supervision.
Details
- Title: Subtitle
- Thoughts on Financial Derivatives, Systematic Risk, and Central Banking: A Review of Some Recent Developments
- Creators
- William C HunterDavid Marchall
- Resource Type
- Working paper
- Publication Details
- Working paper series (Federal Reserve Bank of Chicago), Vol.WP 99-20
- Publisher
- Federal Reserve Bank of Chicago; Chicago, Illinois
- Number of pages
- 30 pages
- Language
- English
- Date posted
- 12/1999
- Academic Unit
- Finance
- Record Identifier
- 9984963233002771
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