Evolution of Non-Recourse Leverage and Complex Risk Structures

The financial system has evolved to include non-recourse leverage which has led to the development of more complex, longer-dated and embedded third and fourth moment type risks. This has resulted in the recycling of risk in the system, as seen during the 2008 financial crisis. The use of multi-year structures and layers of leverage has led to highly complex products with the potential for big asymmetric payouts. Investors are now focusing on possibility distributions rather than probability distributions, aiming to measure entropy outside the probabilistic and capitalize on the asymmetric impact of shifting probability distributions on option pricing.

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