Capital Regulation and Tail Risk

48 Pages Posted: 18 Mar 2011 Last revised: 6 Oct 2011

See all articles by Enrico C. Perotti

Enrico C. Perotti

University of Amsterdam - Finance Group; Centre for Economic Policy Research (CEPR)

Lev Ratnovski

International Monetary Fund; European Central Bank, Financial Research Division

Razvan Vlahu

De Nederlandsche Bank

Multiple version iconThere are 5 versions of this paper

Date Written: July 30, 2011

Abstract

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.

Keywords: Banking, Capital Regulation, Risk-Taking, Tail Risk, Systemic Risk

JEL Classification: G21, G28

Suggested Citation

Perotti, Enrico C. and Ratnovski, Lev and Ratnovski, Lev and Vlahu, Razvan, Capital Regulation and Tail Risk (July 30, 2011). 24th Australasian Finance and Banking Conference 2011 Paper, Available at SSRN: https://ssrn.com/abstract=1787724 or http://dx.doi.org/10.2139/ssrn.1787724

Enrico C. Perotti

University of Amsterdam - Finance Group ( email )

Plantage Muidergracht 12
Amsterdam, 1018 TV
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+31 20 525 4159 (Phone)
+31 20 525 5285 (Fax)

HOME PAGE: http://www.fee.uva.nl/fm/people/pero.htm

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Lev Ratnovski (Contact Author)

European Central Bank, Financial Research Division

Germany

International Monetary Fund ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

HOME PAGE: http://ratnovski.googlepages.com

Razvan Vlahu

De Nederlandsche Bank ( email )

P.O. Box 98
Amsterdam, 1000 AB
Netherlands
+31205242483 (Phone)
+31205242506 (Fax)

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