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Capital Levels and Risk-Taking Propensity in Financial Institutions

11 Pages Posted: 8 Jun 2013  

Giovanni Barone-Adesi

Swiss Finance Institute at the University of Lugano; Ecole Polytechnique Fédérale de Lausanne - Ecole Polytechnique Fédérale de Lausanne

Walter Farkas

University of Zurich, Swiss Finance Institute (SFI) at Department of Banking and Finance; ETH Zürich - Department of Mathematics

Pablo Koch-Medina

University of Zurich - Department of Banking and Finance

Date Written: May 27, 2013

Abstract

Regulators dedicate much attention to the option that financial institutions in distress have to transfer losses to their creditors. It is generally recognized that the existence of this option provides intermediaries with a powerful incentive to keep firm capital close to the minimal requirement. We argue that undercapitalization however harms profitable growth opportunities. Our model quantifies the interaction of these incentives and derives implications for regulation.

Keywords: risk propensity, net tangible value, default option, franchise value

JEL Classification: G31, G32, G18

Suggested Citation

Barone-Adesi, Giovanni and Farkas, Walter and Koch-Medina, Pablo, Capital Levels and Risk-Taking Propensity in Financial Institutions (May 27, 2013). Swiss Finance Institute Research Paper No. 13-33. Available at SSRN: https://ssrn.com/abstract=2274639 or http://dx.doi.org/10.2139/ssrn.2274639

Giovanni Barone-Adesi (Contact Author)

Swiss Finance Institute at the University of Lugano ( email )

Via Buffi 13
CH-6904 Lugano
Switzerland
+41 58 666 4671 (Phone)
+41 58 666 46 47 (Fax)

Ecole Polytechnique Fédérale de Lausanne - Ecole Polytechnique Fédérale de Lausanne

c/o University of Geneve
40, Bd du Pont-d'Arve
1211 Geneva, CH-6900
Switzerland

Walter Farkas

University of Zurich, Swiss Finance Institute (SFI) at Department of Banking and Finance ( email )

Plattenstrasse 14
CH-8032 Zurich, Zurich 8032
Switzerland
+41-44-634 3953 (Phone)
+41-44-634 4345 (Fax)

HOME PAGE: http://https://people.math.ethz.ch/~farkas/

ETH Zürich - Department of Mathematics ( email )

ETH Zentrum HG-F 42.1
Raemistr. 101
CH-8092 Zurich, 8092
Switzerland

HOME PAGE: http://https://people.math.ethz.ch/~farkas/

Pablo Koch-Medina

University of Zurich - Department of Banking and Finance ( email )

Schönberggasse 1
Zürich, 8001
Switzerland

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