What makes a bank risky? Insights from the optimal capital structure of banks
AbstractAssessing the risk of bank failures is the paramount concern of bank regulation. This paper argues that in order to assess the default risk of a bank, it is important to consider its financing decisions as an endogenous dynamic process. We provide a continuous-time model, where banks choose the deposit volume in order to trade off the benefits of earning deposit premiums against the costs that occur at future capital structure adjustments. The bank's asset value may suffer from shocks and follows a jump-diffusion process. Our main finding is that the dynamic endogenous financing decision introduces an important self-regulation mechanism, where it is crucial to distinguish between the diffusion risk and the jump risk component.
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Bibliographic InfoArticle provided by Elsevier in its journal Journal of Banking & Finance.
Volume (Year): 33 (2009)
Issue (Month): 5 (May)
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Web page: http://www.elsevier.com/locate/jbf
Continuous-time model Banking regulation Jump-diffusion process Present value of default costs;
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