Risk externalities and too big to fail

Nassim N. Taleb, Charles S. Tapiero

Research output: Contribution to journalArticlepeer-review

Abstract

This paper establishes the case for a fallacy of economies of scale in large aggregate institutions and the effects of scale risks. The problem of rogue trading and excessive risk taking is taken as a case example. Assuming (conservatively) that a firm exposure and losses are limited to its capital while external losses are unbounded, we establish a condition for a firm not to be allowed to be too big to fail. In such a case, the expected external losses second derivative with respect to the firm capital at risk is positive. Examples and analytical results are obtained based on simplifying assumptions and focusing exclusively on the risk externalities that firms too big to fail can have.

Original languageEnglish (US)
Pages (from-to)3503-3507
Number of pages5
JournalPhysica A: Statistical Mechanics and its Applications
Volume389
Issue number17
DOIs
StatePublished - Sep 1 2010

Keywords

  • Corporate finance
  • Quantitative finance
  • Risk management
  • Tail risks

ASJC Scopus subject areas

  • Statistics and Probability
  • Condensed Matter Physics

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