What should financial regulators do about systemic risk? Ideally, many would like to describe, track, and aggregate the implications of nearly every significant financial contract around the world. Though daunting in scope, doing so would be technically quite feasible. The coordination necessary to make such a system work would be much more challenging than building it. Indeed, at smaller scales, professional risk managers already describe, track, and aggregate contract implications every day. Their data systems, however, are ad hoc and proprietary. Both the inputs and outputs of their risk calculations may be totally incomparable across different organizations-or even within the same institution. What's needed is a way to standardize the characterization of financial contracts.
An international team led by the Stevens Institute of Technology is already working on the open-source software needed. They claim that the cash flow implications of nearly any financial agreement can be accurately approximated using just 30 standardized "contract types." Like Lego blocks, these can fit together to model quite complicated and comprehensive structures. Their widespread use would give both regulators and financial institutions the ability to "put all the pieces together" and model financial risk in ways that are impossible now.
This grant provides funds to support the development and deployment of a pilot open-source "contract typing" software system with the ability to accurately model the cash flow implications of a wide range of financial contracts. Funds will support software development, testing, refinement, infrastructure, and outreach in an attempt to demonstrate the feasibility of such a software system.