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The Impact of Financial Innovations on the Amplification of Financial Crises
- 1 University of Glasgow
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Abstract
A financial crisis arises when the value of financial assets or markets rapidly declines, often leading to panic, liquidity shortages, and the collapse of the banking systems. In modern financial systems, financial innovations such as mortgage-backed securities (MBS), credit default swaps (CDS), and high-frequency trading have emerged as key drivers of both market efficiency and systemic instability. These innovations can amplify financial crises by increasing leverage, introducing complexity, and precipitating abrupt market shocks. This paper examines how specific financial innovations, particularly derivatives like MBS and CDS, contributed to the amplification of the 2007-2008 financial crisis. The study uses a case study approach to analyze the crisis and evaluate both the advantages and disadvantages associated with these financial innovations. The conclusion underscores the necessity for stronger regulation and oversight of financial innovations since unchecked complexity, excessive leverage, and inadequate risk management can precipitate to systemic collapse. Transparent markets, robust risk management practices, and prudent regulation are indispensable in averting and preventing future crises. This research highlights the critical role that financial innovations play in both driving and mitigating financial crises. By analyzing the 2007-2008 American Financial Crisis, the paper provides insights into how these innovations, while offering potential benefits, can also introduce significant risks when improperly regulated. The findings emphasize the necessity of balanced oversight to ensure innovation does not compromise systemic stability.
Keywords
Financial crises, financial innovation, international group, regulations
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Cite this article
Chen,Z. (2025).The Impact of Financial Innovations on the Amplification of Financial Crises.Advances in Economics, Management and Political Sciences,160,68-73.
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