Capital Regulation and Tail Risk

52 Pages Posted: 31 Oct 2011

See all articles by Enrico C. Perotti

Enrico C. Perotti

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

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: August 1, 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 Vlahu, Razvan, Capital Regulation and Tail Risk (August 1, 2011). De Nederlandsche Bank Working Paper No. 307, Available at SSRN: https://ssrn.com/abstract=1951899 or http://dx.doi.org/10.2139/ssrn.1951899

Enrico C. Perotti (Contact Author)

University of Amsterdam - Finance Group ( email )

Plantage Muidergracht 12
Amsterdam, 1018 TV
Netherlands
+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

Tinbergen Institute ( email )

Gustav Mahlerplein 117
Amsterdam, 1082 MS
Netherlands

Lev Ratnovski

International Monetary Fund ( email )

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

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

European Central Bank, Financial Research Division

Germany

Razvan Vlahu

De Nederlandsche Bank ( email )

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

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