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Capital Regulation and Tail Risk

Enrico C. Perotti

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

Lev Ratnovski

International Monetary Fund

Razvan Vlahu

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, G28

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Date posted: March 18, 2011 ; Last revised: October 6, 2011

Suggested Citation

Perotti, Enrico C. 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

Contact Information

Enrico C. Perotti
University of Amsterdam - Finance Group ( email )
Plantage Muidergracht 12
Amsterdam, 1018 TV
+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)
77 Bastwick Street
London, EC1V 3PZ
United Kingdom
Tinbergen Institute ( email )
Gustav Mahlerplein 117
Amsterdam, 1082 MS
Lev Ratnovski (Contact Author)
International Monetary Fund ( email )
700 19th Street, N.W.
Washington, DC 20431
United States
+1 202 623 8213 (Phone)
HOME PAGE: http://ratnovski.googlepages.com
Razvan Vlahu
De Nederlandsche Bank ( email )
P.O. Box 98
Amsterdam, 1000 AB
+31205242483 (Phone)
+31205242506 (Fax)
De Nederlandsche Bank ( email )
PO Box 98
1000 AB Amsterdam
Amsterdam, 1000 AB

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