The Pre-Commitment Approach: Using Incentives to Set Market Risk Capital Requirements

52 Pages Posted: 29 Jul 1997

See all articles by Paul Kupiec

Paul Kupiec

American Enterprise Institute

James M. O'Brien

Board of Governors of the Federal Reserve System - Trading Risk Analysis Section

Date Written: March 1997

Abstract

This paper develops a model of bank behavior that focuses on the interaction between the incentives created by fixed rate deposit insurance and a bank's choice of its loan portfolio and its portfolio of market-traded financial assets. The model is used to analyze the consequences of adopting the Federal Reserve Board's proposed Pre-Commitment Approach (PCA) for setting capital requirements for the market risks of a bank's trading portfolio. Under the PCA, a bank sets its own market risk capital requirement with the knowledge that it will face regulatory penalties should its trading activities generate subsequent losses that exceed its market risk capital pre-commitment.

JEL Classification: G21, G28

Suggested Citation

Kupiec, Paul and O'Brien, James Michael, The Pre-Commitment Approach: Using Incentives to Set Market Risk Capital Requirements (March 1997). Available at SSRN: https://ssrn.com/abstract=100 or http://dx.doi.org/10.2139/ssrn.100

Paul Kupiec (Contact Author)

American Enterprise Institute ( email )

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2028627167 (Phone)

James Michael O'Brien

Board of Governors of the Federal Reserve System - Trading Risk Analysis Section ( email )

Washington, DC 20551
United States

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