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Journal of Financial Econometrics Advance Access originally published online on September 26, 2008
Journal of Financial Econometrics 2009 7(1):3-11; doi:10.1093/jjfinec/nbn014
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© The Author 2008. Published by Oxford University Press. All rights reserved. For permissions, please e-mail: journals.permissions@oxfordjournals.org.

Financial Econometrics, Financial Innovation, and Financial Stability

Charles I. Plosser
     Federal Reserve Bank of Philadelphia

Address correspondence to Charles I. Plosser, e-mail: charles.plosser{at}phil.frb.org.

JEL Classification: E32, E44, E50, G18


  Abstract

Innovation in financial markets, spurred to a significant extent by developments in finance theory and financial econometrics, has played a critical role in spurring economic growth. However, the current turmoil in financial markets raises fundamental questions about the nature of financial innovation and the role of policymakers in maintaining financial stability. This paper explores these questions, focusing on the complexities of modeling financial risk and the potential trade-off between policies aimed at combating short-run financial instability on the one hand and the potential financial market distortions and moral hazard that can result from such policies on the other.

KEYWORDS: credit risk modeling, financial innovation, financial stability, monetary policy

The author is president of the Federal Reserve Bank of Philadelphia. This speech was given at the Inaugural Conference of the Society for Financial Econometrics, New York University Stern School of Business, New York, on June 5, 2008. The views expressed here are those of the author and do not necessarily represent the views of the Federal Reserve Bank of Philadelphia or the Federal Reserve System. I thank Rick Lang and especially Bill Lang for their assistance in preparing this speech.

Received August 21, 2008; revised August 21, 2008; accepted August 21, 2008


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