I got my hands on this excellent "opinion paper" entitled "The Financial Crisis and the Systemic Failure of Academic Economics" by eight well known economists (Dahlem report). The paper outlines what went wrong with economics and finance in retrospect to the current crisis, and track it back (kindly said) to the failure of economics to address the questions that are most relevant to the society and not to make the shortcomings of its models clear.
"Many of the financial economists who developed the theoretical models upon which the modern financial structure is built were well aware of the strong and highly unrealistic restrictions imposed on their models to assure stability. Yet, financial economists gave little warning to the public about the fragility of their models; even as they saw individuals and businesses build a financial system based on their work."
The authors criticize heavily current representative agent economic models and hope that more efforts are put e.g. in network theory and agent based modeling.
"For example, the recent surge of research in network theory has received relatively scarce attention in economics. Given the established curriculum of economic programs, an economist would find it much more tractable to study adultery as a dynamic optimization problem of a representative husband, and derive the optimal time path of marital infidelity (and publish his exercise) rather than investigating financial flows in the banking sector within a network theory framework. This is more than unfortunate in view of the network aspects of interbank linkages that have become apparent during the current crisis."
I have collected a repository of such empirical research here. As is visible in the list, this work has already started at some central banks – as suggested in the report:
"We believe that it will be necessary for supervisory authorities to develop a perspective on the network aspects of the financial system, collect appropriate data, define measures of connectivity and perform macro stress testing at the system level. In this way, new measures of financial fragility would be obtained."
Receipt reactive gross settlement simulator
The Receipt Reactive Gross Settlement (RRGS) method was proposed by Jamie McAndrews in Johnson-McAndrews and Soramaki (2004) as a new, incentive compatible liquidity saving mechanism. The basic idea of RRGS is that banks are sure to use only incoming funds to settle their less urgent payments. Each bank has the incentive to submit payments to the RRGS queue as costly liquidity is consumed only when the bank receives funds from other banks.
This simulator allows simulations of one version of RRGS with historical payment data. It is easy to use and efficient, being able to simulate a day with half a million payments in less than 60 seconds. The fast speed of the simulations and quick set-up allows one to test many alternative scenarios easily.
Read the rest of the entry for instructions on downloading and using this application. You are welcome to get in touch with me for any questions.
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