Systematic Risk, Bank Moral Hazard, and Bailouts

26 Pages Posted: 13 Nov 2017 Last revised: 28 Nov 2017

See all articles by Marcella Lucchetta

Marcella Lucchetta

Ca Foscari University of Venice

Michele Moretto

University of Padua, Dep of Economics and Management

Bruno Maria Parigi

University of Padova - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute)

Multiple version iconThere are 3 versions of this paper

Date Written: November 27, 2017

Abstract

This paper studies the relationship between government bailouts and bank risk taking. We show that the impact of government bailouts (in the form of liquidity injections) on bank risk taking, depends on the exogenous level of systematic risk. In a model where the output follows a geometric Brownian motion and the government guarantees the bank liabilities, we find that: 1) per se more generous bailouts may or may not induce banks to take on more risk depending on systematic risk; in particular if the systematic risk is high (low), a more generous bailout decreases (increases) bank risk taking; 2) the optimal liquidity policy itself depends on systematic risk; 3) When systematic risk is taken into consideration, the relationship between bailouts and bank risk taking is positive, for low systematic risk and when high systematic risk induces tight liquidity policy, and could be negative when high systematic risk induces a very tight liquidity policy, which, in turn, could induce high risk taking.

Keywords: bank closure, real option, systematic risk

JEL Classification: G01, G2

Suggested Citation

Lucchetta, Marcella and Moretto, Michele and Parigi, Bruno Maria, Systematic Risk, Bank Moral Hazard, and Bailouts (November 27, 2017). Available at SSRN: https://ssrn.com/abstract=3068884 or http://dx.doi.org/10.2139/ssrn.3068884

Marcella Lucchetta (Contact Author)

Ca Foscari University of Venice ( email )

Venice
Italy

Michele Moretto

University of Padua, Dep of Economics and Management ( email )

via Del Santo 33
Padova, 35123
Italy
+39 049 8274265 (Phone)
+39 049 8274211 (Fax)

Bruno Maria Parigi

University of Padova - Department of Economics ( email )

via Del Santo 33
Padova, 35123
Italy

CESifo (Center for Economic Studies and Ifo Institute) ( email )

Poschinger Str. 5
Munich, DE-81679
Germany

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