An Evolutionary Theory of Systemic Risk and its Mitigation Outlined for the Global Financial System

A theory of systemic risk is outlined for the global financial system, with practical implications for systemic risk mitigation, based on evolutionary economics viewed from an operational behaviour perspective. The paper begins with an introduction to systemic crises and what motivates this contribution, followed by an explanation of the theory development approach taken. Then a critical review of the main themes in relevant literature leads to a proposed gap in theory. The scope of extant theories is argued to be limited to perceived causes and effects of specific events from the past, with few general insights for recognizing, avoiding and responding to potential failures of this system, wherever they may emerge in the future. After declaring theoretical foundations, new conjectures and propositions from a current programme of research are presented to address that gap and outline a general theory, introducing multidisciplinary notions about: an operational behaviour paradigm of systemic failure for the global financial system; a cusp catastrophe-type model of supply versus demand in systemically important financial services (SIFS) among systemically important participants (SIPs); and four hypotheses for plausibility evaluation. Then a brief discourse explores new opportunities for systemic risk mitigation based on these contributions, qualified by a critical assessment of the value and limitations of the outlined theory, and consideration of its falsifiability. In conclusion, further research is suggested using agent-based methods from computational economics (ACE) to expound, empirically validate and verify this theory, with data about a recent national financial system failure serving as a proxy for similar events in the global financial system. *Winner of 'best paper award' at the Global Finance Conference, Chicago, Illinois, May 22, 2012