Research On The Risk Management Functions Of Modern Financial Intermediaries

The paradigm used in the current theory of financial intermediation is the famous classical idea of the perfect market, introduces by Marshall and Walras and this idea is always the basis point of financial intermediation theory. This paradigm is formalized in the traditional Arrow-Devreu of resource allocation. Financial intermediaries, according to that theory, have a function only because financial markers are not perfect. They exist by the grace of market imperfections. As long as there are market imperfections, there are intermediaries; as soon as markets are perfect, intermediaries are redundant. Thus, in a world with a tendency towards greater market transparency and efficiency, financial intermediaries are an endangered species.However, despite globalization, the information revolution and a much more prominent role of public markets, financial intermediaries appear to survive. Its relative importance in financial system increases considerably.Obviously, traditional asymmetric information and transaction costs are not able to explain this phenomenon.The question that why financial intermediaries play more relative important role in financial system brings the topic about risk management of financial intermediaries that this paper wants to discuss clearly. Under the analysis on the intertemporal smoothing and risk sharing to participation costs, it shows, that the importance of financial intermediaries in financial system comes from its distinct functions feature, which financial markets cannot provide.We call the traditional risk sharing method cross-sectional risk sharing. It is achieved through exchanges of risk among individuals at a given point in time. Risks will be traded so that more risk-averse people bear less of the risk than people who are less risk-averse. These strategies do not eliminate macroeconomic shocks, which affect all assets in a similar way.Departing from the traditional approach, this paper focuses on the intertemporal smoothing of risk. Risks that cannot be diversified at a given point in time cannevertheless be averaged over time in a way that reduces their impact on individual welfare. One hedging strategy for nondiversifiable risks is intergenerational risk sharing, which spreads the risks associated with a given stock of assets across generations with heterogeneous experiences. Another strategy involves asset accumulation in order to reduce fluctuations in consumption over time. Through this method the investors can gain receivable returns and avoid possible loss from market's upturn.The functions of risk sharing under participation costs mainly embody through huge risk trading and risk management. Financial intermediaries can reduce the participation costs of clients by providing products bringing stable cash flows. On the other hand, due to the increasing time value of investors, intermediaries with low participation costs become the hot subject that investors whose direct cost increased will select. At the same time, using the long contract between intermediaries and investors, financial intermediaries can reduce the participation costs and share the risk efficiently.Among the discusses to explain financial intermediaries undertaking financial innovations, risk management and profit gain play the core role. The biggest feature of intertemporal smoothing function is to give investors more returns than that market does when macroeconomy behaves bad. Its weakness is also obvious, that intermediaries will give investors less returns than that market does when macroeconomy behaves good. And under this situation, financial intermediaries will take big pressure of disintermediation. Samely, the contract's stabilization between intermediaries and investors will face assault from markets. How to overcome this problem? The key is to provide innovation products. Through financial innovation, intermediaries can give investors receivable returns and efficiently control potential risks. Simultaneously, it also realize the stabilization and prosperity of financial market.