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The integration of world economies and financial systems is the result of increased trade. The free flow of ideas, goods, and services have led to the globalization of financial markets. The world's economies are becoming more interrelated through trade and international investments. Global financial risk is the potential for a systemic global collapse.
Systemic risk is the risk associated with the collapse of a financial system or the entire market. The global financial risk of total market collapse would most likely occur as a domino effect. Since global financial systems are interrelated, financial system instability could be created by the collapse of a single element within the system.
A chain reaction, or domino effect, may cause a similar collapse in a closely related market. Theoretically, this linked sequence of events could continue to the point of global financial collapse. The financial instability of inter-related markets may contain the catalyst needed to create a self-sustaining chain of events with catastrophic consequences.
It is impossible to determine the potential sequence of events brought about by the failure of a single industry. Sensitive dependence is a phenomenon common to chaos theory. The dependence of interrelated industries may be difficult to establish on a global scale.
The latest development in tracking global financial risk is through giant databases called global risk maps. The risk exposure of banks and large financial institutions are tracked in an attempt to monitor systemic risk. Tracking systemic risk is not preventing systemic risk. Mitigating global financial risk may be incredibly complex.
The Risk Response Network (RRN) has been developed to respond to complex interdependent risk. Corporations, governments, and regulatory authorities have supplied global decision makers to form a community of Risk Officers. These officers have at their disposal the most advanced risk analysis and risk management processes and tools. Proactive response is expected in times of financial crisis.
Technology and access to better and more complete information may be the answer to global financial risk mitigation. Transparency in the over-the-counter (OTC) sector may broaden access to information and result in electronic trading platforms connected to centralized counterparty clearinghouses. Access to technology might expose underlying problems in the financial markets.
Regulatory efforts are in effect to eliminate OTC markets and set up exchanges to replace them. Some believe that no amount of regulation can overcome the lack of technology or intentional manipulation. In order to replace OTC trading with exchange trading, markets may have to be restructured. Liquidity and volatility issues may be the unintended consequences of excessive regulation. Global financial risk mitigation is a work in progress.
An excellent example of interconnectedness and the need for financial risk analysis is the effect of Russian default on latin american markets simply because investors had to sell off south american holdings to cover losses on Russian assets. The only connection was common ownership.