An Information Market Proposal for Regulating Systemic Risk

University of Pennsylvania Journal of Business Law, Vol. 12, No. 3, 2010

FSU College of Law, Public Law Research Paper No. 389

FSU College of Law, Law, Business & Economics Paper No. 09-23

41 Pages Posted: 27 Aug 2009 Last revised: 7 Nov 2009

See all articles by Matthew L. Beville

Matthew L. Beville

affiliation not provided to SSRN

Dino Falaschetti

US Treasury

Michael J. Orlando

Econ One Research, Inc.; University of Colorado - Denver

Date Written: August 24, 2009

Abstract

Legislators are calling for a “systemic risk regulator”, in part to provide an early warning of financial conditions that threaten the real economy. To succeed, however, we need a forward-looking measure of systemic risk. Even more, we need a measure that varies with “pollution” from financial transactions, not private costs and benefits on which popularly cited measures (such as the TED spread) are based. Our article thus proposes a new contract, one that derives from financial correlations that emerge from systemically consequential actions (i.e., financial transactions that affect third parties), and leverages important advantages of information markets (namely, incentives for individuals who are closest to relevant information to rationally develop and truthfully reveal expectations). We also offer a statistical back-test of our proposed contract, and find evidence that it could have anticipated important changes in systemic risk over the past ten years. Finally, we consider how this type of contract can be implemented within existing information market regulations, and how information from trading the contract can improve conventional tools of financial regulation (e.g., bank examinations, capital requirements).

Keywords: Systemic risk, financial contagion, information markets, financial regulation

Suggested Citation

Beville, Matthew L. and Falaschetti, Dino and Orlando, Michael J., An Information Market Proposal for Regulating Systemic Risk (August 24, 2009). University of Pennsylvania Journal of Business Law, Vol. 12, No. 3, 2010, FSU College of Law, Public Law Research Paper No. 389, FSU College of Law, Law, Business & Economics Paper No. 09-23, Available at SSRN: https://ssrn.com/abstract=1461003

Matthew L. Beville

affiliation not provided to SSRN

Dino Falaschetti (Contact Author)

US Treasury ( email )

Office of Financial Research
Washington, DC District of Columbia 20220
United States

Michael J. Orlando

Econ One Research, Inc. ( email )

United States

University of Colorado - Denver ( email )

1475 Lawrence St.
Suite 4001
Denver, CO 80202
United States

HOME PAGE: http://www.ucdenver.edu/academics/colleges/business/degrees/ms/gem/Pages/faculty.aspx

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