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(More customer reviews)The Clarendon lectures by Hyun Shin represent collection of ideas he has developed over the past 10-15 years.
Many of these ideas preceded the financial crisis and were in fact prescient as to how the crisis came about.
While the book touches in important ways on both aspects of its title "risk" and "liquidity", the ideas about risk
are the most potent and in fact drive the book's thesis about liquidity.
The key idea is simple and explained beautifully well: that much of modern risk management - both inside
banks and that which is adopted by Basel capital requirements - is highly firm-centric or partial equilibrium
in view. It does not recognize that individual agents, taking the same action in interest of reducing each one's
risk in isolation can in fact make the system more fragile. These common actions could be building exposures to
mortgage-backed securities because Basel has encouraged them to do by lower capital requirements, or liquidating
assets all at once since they have all hit their risk limits based on common model assumptions. That risk of the
system is thus ENDOGENOUS to the very rules that are designed to reduce this risk is a subtle point that can help
understand much of what went in lead-up and unfolding of the recent crisis. It also helps understand why financial
firms and their employees, working each in their own self-interests, found it surprising that the aggregate outcome
of their actions was so calamitous.
The book also builds rich ideas around liquidity in asset markets and on balance-sheets, in turn being endogenous
to choices of agents in the economy, and how measures adopted to limit agency problems such as mark-to-market
accounting can similarly exacerbate market liquidity in times when several firms are close to their risk management
constraints at once. The book then goes on to suggest sound principles for - especially MACRO-PRUDENTIAL -
regulation of the financial system, principles that recognize the fallacy of composition and that guard against the
fact that risk and liquidity are endogenous to regulation itself.
The author, as part of a group of colleagues at London School of Economics (along with Charles Goodhart in particular)
had forewarned in 2002 in a report that Basel risk-weights are likely to endogenously make certain asset classes
more systemic and the economic cycle more severe in a downturn. Their academic thinking, like that of some others,
however went unheeded. The hope is that the ideas in these Clarendon lectures will receive more serious attention
and can be kept in mind as financial regulation is rewritten. I encourage everyone interested in financial markets,
crises and regulation to read this important contribution, in academia, practice and policy alike.
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This book presents the Clarendon Lectures in Finance by one of the leading exponents of financial booms and crises. Hyun Song Shin's work has shed light on the recent global financial crisis and he has been a central figure in the policy debates.The paradox of the global financial crisis is that it erupted in an era when risk management was at the core of the management of the most sophisticated financial institutions.This book explains why.The severity of the crisis is explained by financial development that put marketable assets at the heart of the financial system, and the increased sophistication of financial institutions that held and traded the assets. Step by step, the lectures build an analytical framework that take the reader through the economics behind the fluctuations in the price of risk and the boom-bust dynamics that follow.The book examines the role played by market-to-market accounting rules and securitisation in amplifying the crisis, and draws lessons for financial architecture, financial regulation and monetary policy.This book will be of interest to all serious students of economics and finance who want to delve beneath the outward manifestations to grasp the underlying dynamics of the boom-bust cycle in a modern financial system - a system where banking and capital market developments have become inseparable.
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