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Abstract
This chapter assesses how market risk management techniques may have contributed to the benign financial environment of recent years, and whether seemingly prudent behavior by individual firms, reacting to similar market risk systems, could serve to amplify market volatility in periods of stress beyond what would otherwise have occurred. Based on simulations and observed risk management practice, there are grounds for believing that this could be the case. Results of the simulations suggest that, in a period of stress, having a variety of risk models is more stabilizing than uniformity. Perhaps more important, however, is the presence of a variety of types of financial institutions with differing investment horizons and risk appetites, as well as the scope to take offsetting positions when prices overshoot and “fire sales” occur.
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