Competition Theory of Risk Management Failures

57 Pages Posted: 6 Jun 2015 Last revised: 16 Jun 2019

See all articles by Matthieu Bouvard

Matthieu Bouvard

McGill University - Desautels Faculty of Management

Samuel Lee

Santa Clara University - Leavey School of Business; European Corporate Governance Institute (ECGI); Swedish House of Finance

Date Written: August 2017

Abstract

We model risk management as information acquisition that creates latency for trading firms engaged in preemptive competition. Since time pressure is endogenous to risk management decisions, strategic complementarities sustain a ``race to the bottom" where prioritizing trade execution over risk management is optimal for each firm, but collectively inefficient. As time competition intensifies, mean trading profitability supplants higher-order risk moments in risk management decisions, causing misallocation of risks to increase together with trading volume and immediacy. This pathology of risk management failures -the trio of boom markets, preemptive competition, and time-consuming risk assessments- has distinct regulatory implications.

Keywords: Banks, Risk Management, Time Pressure, Coordination Failure, Global Games

JEL Classification: G20, G21, G28

Suggested Citation

Bouvard, Matthieu and Lee, Samuel, Competition Theory of Risk Management Failures (August 2017). Paris December 2015 Finance Meeting EUROFIDAI - AFFI; European Corporate Governance Institute (ECGI) - Finance Working Paper No. 454/2015. Available at SSRN: https://ssrn.com/abstract=2614468 or http://dx.doi.org/10.2139/ssrn.2614468

Matthieu Bouvard (Contact Author)

McGill University - Desautels Faculty of Management ( email )

1001 Sherbrooke St. West
Montreal, Quebec H3A1G5 H3A 2M1
Canada

Samuel Lee

Santa Clara University - Leavey School of Business

500 El Camino Real
Santa Clara, CA California 95053
United States

European Corporate Governance Institute (ECGI) ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

Swedish House of Finance ( email )

Drottninggatan 98
111 60 Stockholm
Sweden

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