Bank Risk Dynamics Where Assets are Risky Debt Claims

29 Pages Posted: 10 Jan 2017

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: January 2017

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

Suggested Citation

Peleg Lazar, Sharon and Raviv, Alon, Bank Risk Dynamics Where Assets are Risky Debt Claims (January 2017). European Financial Management, Vol. 23, Issue 1, pp. 3-31, 2017, Available at SSRN: https://ssrn.com/abstract=2896469 or http://dx.doi.org/10.1111/eufm.12102

Sharon Peleg Lazar (Contact Author)

Tel Aviv University ( email )

Tel Aviv
Israel

Alon Raviv

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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