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

Abstract

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

Rau-Bredow, Hans, Bigger Is Not Always Safer: A Critical Analysis of the Subadditivity Assumption for Coherent Risk Measures (August 26, 2019). 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. Available at SSRN: https://ssrn.com/abstract=3447172

Hans Rau-Bredow (Contact Author)

University of Wuerzburg ( email )

Faculty of Business Management and Economics
Sanderring 2
Würzburg, DE Bavaria D-97070
Germany

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