Bank Capital Structure and Tail Risk

51 Pages Posted: 18 Mar 2020 Last revised: 10 Aug 2021

See all articles by Suzanne Vissers

Suzanne Vissers

Ecole Polytechnique Fédérale de Lausanne; Swiss Finance Institute

Date Written: February 23, 2020

Abstract

This paper presents a bank capital structure model in which bank assets are subject to both diffusion and tail risk. Of these two types of risk, tail risk causes uninsured deposits to be risky, as the bank's asset value can unexpectedly fall below the value of deposits in case of default. The model shows that tail risk, rather than diffusion risk, is the main driver of the risk on deposits when the bank is unregulated and of the endogenous deposit insurance premium when the bank is regulated. Keeping total volatility constant, the model shows that a high tail risk component leads to higher credit spreads, default risk, and magnitude of bank losses in default than a high diffusion risk component.

Keywords: Banking, Optimal Capital Structure, Financial Regulation, Tail Risk, Jump-Diffusion Models

JEL Classification: G21, G28, G32, G33

Suggested Citation

Vissers, Suzanne, Bank Capital Structure and Tail Risk (February 23, 2020). Available at SSRN: https://ssrn.com/abstract=3354640 or http://dx.doi.org/10.2139/ssrn.3354640

Suzanne Vissers (Contact Author)

Ecole Polytechnique Fédérale de Lausanne ( email )

Quartier UNIL-Chamberonne
Extranef 128
1015 Lausanne, CH-1015
Switzerland

HOME PAGE: http://www.suzannevissers.com

Swiss Finance Institute

c/o University of Geneva
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Geneva 4, CH-1211
Switzerland

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