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Risk Is Worse When You Can’t See It 

September 7, 2016

Mark Buchanan, BloombergView

Financial crises are becoming more frequent as markets and the rules that govern them grow ever more complex. New research suggests that this is no coincidence -- and that a simpler system would be a lot more resilient.

Forward-thinking officials have long argued that financial regulation needs to be simpler. In his much-quoted speech "The Dog and the Frisbee," Andrew Haldane of the Bank of England notes that dogs catch frisbees not by making complex aerodynamic calculations, but by relying on simple rules of thumb -- for example, running at a speed that keeps the angle of gaze to the object roughly constant. By analogy, he suggested, regulators might do well to eschew ever more intricate calculations of the risks in banks’ portfolios, and instead aim for rules that would be easier to understand and less likely to go badly wrong.

The point also applies to the dense networks of contracts and relationships that link financial firms together. As these get more complex, a new study shows, markets naturally become less stable, because the risks become difficult to perceive and manage.

This isn’t your typical economics paper. The authors include Nobel Prize winning economist Joseph Stiglitz and renowned mathematical ecologist Robert May, who teamed up with physicists to explore the consequences of network complexity in a way traditional research has not. Read more

 
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