Chapter

The Economic Theory of Systemic Risk

E. Philip Davis

in Debt, Financial Fragility, and Systemic Risk

Published in print October 1995 | ISBN: 9780198233312
Published online November 2003 | e-ISBN: 9780191596124 | DOI: http://dx.doi.org/10.1093/0198233310.003.0006
The Economic Theory of Systemic Risk

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Turning from financial fragility to systemic risk, the next two chapters seek to make an initial assessment of the causes, nature, and consequences of financial instability in contemporary financial markets by means of an examination of the features of six recent periods of financial disorder, in the light of the various theoretical approaches to financial crisis that have been proposed in the literature. To what extent did financial instability follow directly from financial fragility in the non‐financial sectors, with defaults by companies or households progressively weakening the balance sheets of financial institutions? Or were risks other than credit risk primarily responsible? Were the periods of financial instability ‘unique events’ or can common features be discerned? How well do the predictions of the theoretical paradigms fit the actual data? This chapter provides the theoretical background, while Ch. 6 offers an empirical assessment. We cover the financial fragility, monetarist, uncertainty, credit rationing/disaster myopia, and asymmetric information strands of the theory of financial instability.

Keywords: asymmetric information; credit rationing; credit risk; financial disorder; financial fragility; financial instability; financial institutions; monetarist; systemic risk; uncertainty

Chapter.  14323 words. 

Subjects: Financial Markets

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