Understanding Systemic Risk in Global Financial Markets

Solutions to the Knowledge Check Questions

Chapter 1

1. A1.1: The key distinguishing characteristic of a systemic risk event is the fact that the impact of such events spills over into the real economy.

2. A1.2: No. Systemic events have been occurring since at least the Middle Ages, with the most documented event dating back to the 1600s, called the “Dutch Tulip Crisis,” in which many European investors and regular citizens took significant losses, in many cases their life savings, by making concentrated bets on the price of tulip bulbs on the futures market.

3. A1.3: Inflation spikes; currency crashes; currency debasements; bursting of asset bubbles; banking crisis and sovereign defaults.

4. A1.4: The insolvency of hundreds of U.S. banks was at the center of both the Great Depression and the Credit Crisis.

5. A1.5: It is critical that in the future systemic risks are better anticipated and mitigated to minimize the negative costs of such events on both the financial services sector as well as society, which often bears the cost of government bailouts.

Chapter 2

1. A2.1: An asset bubble can be described as a non-sustainable pattern of price changes or cashflows that eventually suffers a precipitous decline in a short period of time.

2. A2.2: Although not a precondition for an asset bubble, many popular economic theories hold that “easy credit” conditions provided by Central Banks usually exist in the years leading up to a bubble. These conditions allow investors to speculate on investments, ...