| Summary: | Systemic risk, the possibility that a triggering event such as the failure of a large financial firm will seriously impair financial markets and harm the broader economy, has taken centre stage since the recent global financial crisis. In the wake of the crisis, policy-makers worldwide have recognised the need to fill gaps in our understanding of the dynamics of the financial system, its non-linear relationship with the real economy, and the factors responsible for alternating phases of stability and instability characterising the system. This thesis addresses the aforementioned gaps under three main headings related to systemic risk: overlapping portfolios, risk diversification and policy interaction. The insights developed suggest that specialised financial institutions pose a great risk to the stability of the financial system when banks are indirectly connected via overlapping portfolios. Furthermore, this work shows that diversification serves multiple roles in relation to financial stability; on the one hand diversification reduces the risk of an isolated bank failure, but on the other hand it increases the risk of many joint failures. The findings of the analyses are used to propose regulatory policies for improving financial stability and social welfare. Lastly, in a bid to avoid the fallacy of composition risk that is associated with the study of regulatory policies in isolation, this thesis also attempts to identify the complex interactions of resolution, monetary, and macro-prudential policies.
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