"The vulnerability of a national economy to volatility in the global markets for credit, currencies, commodities, and other assets has become a central concern of policymakers," said Nobel Laureate Professor Robert Merton at the Business Forum on Global Systemic Risk and Global Financial Stability.
Held by the Institute of Global Finance (IGF) in collaboration with PwC and Finsia, he gave a keynote address "On a New Approach for Analysing and Managing Macro-financial Risk, and Risk and Performance Measurement in Asset Management" which was well attended, including by Philip Lowe, the Deputy Governor of the Reserve Bank of Australia.
"Never imagine that this is a new problem," he said. "The good old days were very scary, with double digit inflation, oil prices increasing exponentially, and the end of the Bretton Woods system of monetary management. I lived through the economic crisis of the 1970s - which came right after we were told that economic instability had been solved - and the markets proved they were very inefficient. However that era sparked much of the financial innovation we are seeing now. Credit risk is always with us, and if you understand that, you won't make it go away, but at least you can mitigate it."
Professor Robert Merton is a Senior Fellow at the IGF, which is located at UNSW's Australian School of Business. He said "the systems that constitute the global financial landscape have become increasingly interconnected since the global financial crisis, but policy makers have lagged behind the trend and still manage financial stability policies in isolation. With macro-financial risk, you have to analyse the connectedness. In 2004-07 we were much less connected than we were in 2009-12, as new financial instruments magnified the risk around the world."
He demonstrated a new modelling tool which showed the connectivity between institutions. "In 2012, the US seemed to be separating itself from credit risk, where the main connections seemed to be within Europe, and particularly Greece and Italy. However if you look closely, financial institutions within the US such as Goldman Sachs appeared to be married to Spain at the time."
Professor Robert Merton is the MIT Sloan School of Management Distinguished Professor of Finance. He added that this new technology is market based, and reacts as people carry on trading, which means it shows problems very quickly. "With risk, the analogy of an elephant is important. Quite often everyone can describe only part of the elephant that they are holding - no one will tell you about the whole animal in the room. However technology allows us to see risk as it spreads around the globe. If only we had this new instrument before Leman Brothers collapsed."
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