Mathematics in Finance: Systemic Risk
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Mathematics in Finance: Systemic Risk

George Papanikolaou of Stanford University discussed systemic risk at the 2012 siam annual meeting in finance systemic risk refers to the risk caused by the interconnectedness with in a financial system where the failure of a single entity or group of entities could cause that system to collapse in what environment is the system operating are there is a system operating in an environment that is very very stormy very unstable very prone to shocks systemic risk plays a part in how governments respond to financial crises including recent economic downturns in the US and Europe we so graphically how interconnected the economies where and how although the the impulse of the of the US government of the Federal Reserve was to collect certain failing institutions outright fail and they realized that they didn't have a choice but to rescue some of them because they would have caused the contagion and it would have been bad for everybody so they had to step in that's a very graphic instance of systemic risk which called for government intervention to stop to stop from events happening that nobody wanted to happen if you increase the interconnectivity sufficiently then you will create more or less a stable system or at least a quasi stable system you will spend a long time on one state and a long time with the other you begin to see that interconnectivity already at this level interconnectivity really helps at the individual level says just jack up the interconnectivity and you will be fine and of course that's precisely what I want to say you don't get that you pay a price for that we just want to find out what system increased exactly is to quantify it identify situations that generate systemic risk certain types and behaviors as much quantification as possible we want to take it out of the day of the speculative we want to put it into a full quantitative framework we want to not only use empirical evidence which is of course that the starting point of everything is the empirical evidence but we want to create models that can be predicted but at least at first they can be indicative of what can happen and eventually be predictive that's a long shot to have predictive models for systemic behavior Papanikolaou emphasized the leading role that mathematicians must take in performing the research needed to minimize systemic risk in the end research is done by because somebody's interested in it and you look at the participants in is that the banks are really not interested they haven't supported research in the last 15 20 years I've been in this field they haven't supported it take their the users of our research and they have benefited enormously from it dr. Papanicolaou hopes that economists and bankers will begin taking an interest in systemic risk research similar to the way the economics community turned to modern finance research a couple of decades ago just like you know when modern financial mathematics mathematics started in the early seventies with options pricing it wasn't the economics community that did it it was the applied mathematics community and I perceive that systemic risk could take a turn like that

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