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A regulatory arbitrage game: Off-balance-sheet leverage and financial fragility

Author

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  • Dimitris Voliotis

    (University of Piraeus)

Abstract

This study examines a simple banking system in a game-theoretic framework wherein banks act as self-interested agents to maximize leverage at the expense of overall financial stability. The resultant strategic inefficiency raises concerns about how banks manage the "financial stability" good, which is appropriated into a "tragedy of the commons." We conceptualize the inefficiency using the price of anarchy introduced by Koutsoupias and Papadimitriou (2009). We seek the optimal regulatory framework that minimizes the price of anarchy or the degree of financial fragility.

Suggested Citation

  • Dimitris Voliotis, 2022. "A regulatory arbitrage game: Off-balance-sheet leverage and financial fragility," The Journal of Mechanism and Institution Design, Society for the Promotion of Mechanism and Institution Design, University of York, vol. 7(1), pages 131-150, December.
    • Handle: RePEc:jmi:articl:jmi-v7i1a5
    DOI: 10.22574/jmid.2022.12.005
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    References listed on IDEAS

    as
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    4. Jones, David, 2000. "Emerging problems with the Basel Capital Accord: Regulatory capital arbitrage and related issues," Journal of Banking & Finance, Elsevier, vol. 24(1-2), pages 35-58, January.
    5. Pradeep Dubey, 1986. "Inefficiency of Nash Equilibria," Mathematics of Operations Research, INFORMS, vol. 11(1), pages 1-8, February.
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    More about this item

    Keywords

    Financial fragility; congestion games; price of anarchy; best response potential.;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games

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