Bank Capital Structure and Tail Risk

47 Pages Posted: 18 Mar 2020

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 continuous-time bank capital structure model in which the bank's assets are subject to both diffusion and tail risk. The latter causes uninsured deposits to be risky, as the bank's assets can jump below the threshold at which it is optimal for depositors to run. The model shows that tail risk, rather than diffusion risk, is the main driver of the credit spread 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 an increase in tail risk leads to higher credit spreads and bankruptcy costs than an increase of diffusion risk. Furthermore, a bank with frequent but small asset jumps is safer than one with infrequent but large asset jumps.

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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