Wednesday, November 12, 2008

Thus, the loss of market value of sub-prime securities just since early 2007 totals around $380 billion (IMF, OECD 2008).

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In an environment of electronically linked and globalised markets and rapid innovations, risk and uncertainty assume specific meanings and weight.

The IMF estimates the loss in the US linked to sub-prime mortgages at $144 billion. Because it is also the largest, investors from all over the world are likely to buy US instruments and thereby to see losses. Indeed, the US spillover effects on other markets are significant. According to the IMF, all economies have experienced spillover effects from US subprime housing market: it finds that the European Union as a whole lost $123 billion, Canada $7 billion, Japan lost about $10 billion, and other Asian countries combined lost about $13 billion. This is evidence of the global circulation of mortgage backed-securities. Within the EU, the country whose financial system is most intertwined with the US, the United Kingdom, will see a sub-prime mortgage linked loss of $40 billion, followed by Switzerland’s loss of $23 billion. Thus, the loss of market value of sub-prime securities just since early 2007 totals around $380 billion (IMF, OECD 2008).

As for the second dynamic, network effects, it concerns the impact of complex financial instruments meant to reduce risk on electronically linked financial markets. The electronic linking of markets (both nationally and globally), the accelerated rise in innovations enabled by both financial economics and digitisation, and the sharp growth in the use of a particular type of financial instrument, the derivative, have come together in ways that have launched a new phase in financial markets. The diversification and dominance of derivatives has raised the complexity of operations and has further facilitated the linking of different financial markets. In an environment of electronically linked and globalised markets and rapid innovations, risk and uncertainty assume specific meanings and weight. This, in turn, partly explains why derivatives have become the most widely used financial instrument.


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Source :
IIPM Editorial, 2008
An Initiative of IIPM, Malay Chaudhuri and
Arindam Chaudhuri (Renowned Management Guru and Economist).


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