Do Financial Regulations Shape the Functioning of Financial Institutions’ Risk Management in ABS Investment?
Review of Financial Studies, Forthcoming
61 Pages Posted: 24 Jul 2017 Last revised: 14 Nov 2019
Date Written: March 12, 2019
We show that installing stronger risk management into financial institutions – a proposal widely discussed following the 2008 financial crisis – is insufficient to constrain institutions’ exposure to investment with lurking risk, such as asset-backed securities. Financial regulations affect the functioning of risk management: risk management constrains institutions’ exposure to risky ABS when they face mark-to-market reporting combined with capital requirements; however, this role is considerably weaker when capital requirements are combined with historical-cost-accounting. We find suggestive evidence that financial regulations affect risk management functions through promoting risk managers’ efforts in uncovering ABS risk and curbing executives’ incentives to take excessive risk.
Keywords: financial institutions; asset-backed securities; risk management; financial regulations
JEL Classification: G11, G22, G28, G32
Suggested Citation: Suggested Citation