Sunday, December 12, 2010
Marginalizing Risk, by Steven L. Schwarcz, Duke University - School of Law, was recently posted on SSRN. Here is the abstract:
A major focus of finance is reducing risk on investments, in order to reduce a borrower’s costs of funds. From any given investor’s standpoint, risk dispersion appears as an important way to reduce investment risk; but sometimes risk dispersion can cause investors and other market participants to underestimate and under-protect against risk. Risk can even be so widely dispersed that rational market participants individually lack the incentive to monitor it. This article examines the market failures resulting from risk dispersion that can cause market participants to under-protect against risk. The article also analyzes the extent to which government regulation may be necessary or appropriate to limit these market failures. Finally, the article examines how such regulation should be designed, including the extent to which it should limit risk dispersion in the first instance.