Bank Risk Dynamics Where Assets Are Risky Debt Claims

40 Pages Posted: 3 Jun 2016 Last revised: 23 Jun 2016

See all articles by Sharon Peleg Lazar

Sharon Peleg Lazar

Tel Aviv University

Alon Raviv

Bar-Ilan University - Graduate School of Business Administration

Multiple version iconThere are 2 versions of this paper

Date Written: June 1, 2016

Abstract

The structural approach views firm's equity as a call option on the value of its assets, which motivates stockholders to increase risk. However, since bank assets are risky debt claims, bank equity resembles a subordinated debt. Using this assumption, and considering the strategic interaction between a bank and its debtor, we argue that risk shifting is limited to states in which the debtor is in financial distress. Furthermore, risk shifting increases with bankruptcy costs and decreases with bank capital. Thus, increasing a bank's capital affects stability, not only through the additional capital buffer, but also by affecting the risk shifting incentive.

Keywords: Risk taking, Asset risk, Financial institutions, Stress test, Leverage

JEL Classification: G21, G28, G32, G38

Suggested Citation

Peleg Lazar, Sharon and Raviv, Alon, Bank Risk Dynamics Where Assets Are Risky Debt Claims (June 1, 2016). Available at SSRN: https://ssrn.com/abstract=2788106 or http://dx.doi.org/10.2139/ssrn.2788106

Sharon Peleg Lazar

Tel Aviv University ( email )

Tel Aviv
Israel

Alon Raviv (Contact Author)

Bar-Ilan University - Graduate School of Business Administration ( email )

The Graduate School of Business Administration
Ana and Max Web st
Ramat Gan
Israel

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