We model a Systemically Important Financial Institution (SIFI) that is too big (or too interconnected) to fail. Without credible regulation and strong supervision, the shareholders of this institution might deliberately let its managers take excessive risk. We propose a solution to this problem, showing how insurance against systemic shocks can be provided without generating moral hazard. The solution involves levying a systemic tax needed to cover the costs of future crises and more importantly establishing a Systemic Risk Authority endowed with special resolution powers, including the control of bankers' compensation packages during crisis periods.
The pricing kernel is an important link between economics and finance. In standard models of financial economics, it is proportional to the aggregate marginal utility in the economy. We first show that none of the three standard assumptions (completeness, risk aversion, and correct beliefs) is needed for the pricing kernel to be generally decreasing. If at least one of the three assumptions is violated, the pricing kernel can have increasing parts. We explain the economic principles that lead to an increasing part in the pricing kernel and compare the resulting pricing kernels with the empirical pricing kernel estimated in Jackwerth (2000, Rev. Financ. Stud., 13, 433–451).
Structured financial products have gained more and more popularity in recent years, but nevertheless has their success so far not thoroughly been analyzed. In this article we develop a theoretical framework for the design of optimal structured products and analyze the maximal utility gain for an investor that can be achieved by introducing structured products. We demonstrate that most successful structured products are not optimal for a perfectly rational investor and investigate the reasons that make them nevertheless look so attractive for many investors
