Bigger Is Not Always Safer: A Critical Analysis of the Subadditivity Assumption for Coherent Risk Measures
Rau-Bredow, Hans: Bigger is not Always Safer: A Critical Analysis of the Subadditivity Assumption for Coherent Risk Measures, in: Risks 2019, 7(3), 91: DOI:10.3390/risks7030091
18 Pages Posted: 11 Sep 2019
Date Written: August 26, 2019
This paper provides a critical analysis of the subadditivity axiom, which is the key condition for coherent risk measures. Contrary to the subadditivity assumption, bank mergers can create extra risk. We begin with an analysis how a merger affects depositors, junior or senior bank creditors, and bank owners. Next it is shown that bank mergers can result in higher payouts having to be made by the deposit insurance scheme. Finally, we demonstrate that if banks are interconnected via interbank loans, a bank merger could lead to additional contagion risks. We conclude that the subadditivity assumption should be rejected, since a subadditive risk measure, by definition, cannot account for such increased risks.
Keywords: coherent risk measures; subadditivity; bank mergers; regulatory capital
JEL Classification: G21; G32; G34
Suggested Citation: Suggested Citation