Capital Regulation and Tail Risk
Enrico C. Perotti
University of Amsterdam - Finance Group; Centre for Economic Policy Research (CEPR); Tinbergen Institute
International Monetary Fund
De Nederlandsche Bank; De Nederlandsche Bank
July 30, 2011
24th Australasian Finance and Banking Conference 2011 Paper
The paper studies risk mitigation associated with capital regulation, in a context where banks may choose tail risk assets. We show that this undermines the traditional result that higher capital reduces excess risk-taking driven by limited liability. Moreover, higher capital may have an unintended effect of enabling banks to take more tail risk without the fear of breaching the minimal capital ratio in non-tail risky project realizations. The results are consistent with stylized facts about pre-crisis bank behavior, and suggest implications for the optimal design of capital regulation.
Number of Pages in PDF File: 48
Keywords: Banking, Capital Regulation, Risk-Taking, Tail Risk, Systemic Risk
JEL Classification: G21, G28working papers series
Date posted: March 18, 2011 ; Last revised: October 6, 2011
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