Competition Theory of Risk Management Failures

63 Pages Posted: 6 Jun 2015 Last revised: 10 Jul 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 1, 2017

Abstract

We study a model in which firms compete preemptively for trading opportunities and risk management introduces latency in trading. As the time pressure faced by firms is endogenous to risk management choices, strategic complementarities can trigger a “race to the bottom” where prioritizing trade execution over risk management is individually optimal, but collectively inefficient. This generates an inverse relationship between trading volume/immediacy and efficiency of risk allocation. Different from theories where financing frictions or risk shifting cause a lack of risk management, ours predicts the pathology of risk management failures to be the trifecta of (1) “boom” markets, (2) time-based competition, and (3) firms in which risk assessment is time-consuming. We discuss merits and drawbacks of taxation, fines, and market design as possible countermeasures.

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 1, 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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