Searching For Causes Of The Current Financial Crisis: On Risk Underassessment And Ignorance

The paper presents the author’s views on one underlying cause of the current financial crisis: the erroneous assessment of risk by market participants. We argue that besides other convincing explanations of the causes behind the recent financial turmoil such as loose government and central bank policies, the process of market liberalization, investors’ appetite for risk and excessive financial modeling, we need to recognize the fact that underassessment of risk by market participants and policy makers is a major cause for the current crises, as for previous ones. This underestimation of risk comes largely as a result of two realities: first, risk magnitude was not entirely known by market participants, due to an interlinking of securities, structures, and derivatives built around the subprime mortgages; second, market participants ignored these risks to a large extent, in a world were access to financial markets was as easy as never before.