Risk Averse Banks and Uncertain Correlation Values: A Theory of Rational Panics

Oxford Financial Research Centre Working Paper No. 2000-FE-08

34 Pages Posted: 15 Feb 2001  

Alan D. Morrison

University of Oxford - Said Business School; University of Oxford - Merton College

Date Written: December 11, 2000

Abstract

We present a model for financial fragility in which there is uncertainty over risk management parameters and there is a danger of disinvestment caused by heightened risk aversion. Projects in small economies are assumed to be riskier than those in large economies. In this situation there is a danger that a rise in project correlations will lead to a rational but unnecessary recession. We conclude firstly that greater transparency in the dissemination of correlation parameters is desirable and secondly that regulators should respond to heightened financial fragility by relaxing capital adequacy requirements.

Keywords: Banking, systemic risk, financial fragility, panics, capital adequacy, bank regulation, Value at Risk

JEL Classification: C72, G21, G28

Suggested Citation

Morrison, Alan D., Risk Averse Banks and Uncertain Correlation Values: A Theory of Rational Panics (December 11, 2000). Oxford Financial Research Centre Working Paper No. 2000-FE-08. Available at SSRN: https://ssrn.com/abstract=255229 or http://dx.doi.org/10.2139/ssrn.255229

Alan Morrison (Contact Author)

University of Oxford - Said Business School ( email )

Department of Finance
Park End Street
Oxford OX1 1HP
United Kingdom
+44 18 6527 6343 (Phone)
+44 18 6527 6310 (Fax)

University of Oxford - Merton College

Merton Street
Oxford OX1 4JD
United Kingdom
+44 18 6527 6343 (Phone)

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