An Axiomatic Approach to Systemic Risk

Systemic risk refers to the risk of collapse of an entire complex system as a result of the actions taken by the individual component entities or agents that comprise the system. Systemic risk is an issue of great concern in modern financial markets as well as, more broadly, in the management of complex business and engineering systems. We propose an axiomatic framework for the measurement and management of systemic risk based on the simultaneous analysis of outcomes across agents in the system and over scenarios of nature. Our framework defines a broad class of systemic risk measures that accomodate a rich set of regulatory preferences. This general class of systemic risk measures captures many specific measures of systemic risk that have recently been proposed as special cases and highlights their implicit assumptions. Moreover, the systemic risk measures that satisfy our conditions yield decentralized decompositions; i.e., the systemic risk can be decomposed into risk due to individual agents. Furthermore, one can associate a shadow price for systemic risk to each agent that correctly accounts for the externalities of the agent's individual decision making on the entire system.