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Capital Regulation and Tail Risk

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Author Info

  • Enrico Perotti
  • Lev Ratnovski
  • Razvan Vlahu

Abstract

The paper studies risk mitigation associated with capital regulation, in a context where banks may choose tail risk assets. We show that this undermines the traditional result that higher capital reduces excess risk-taking driven by limited liability. Moreover, higher capital may have an unintended effect of enabling banks to take more tail risk without the fear of breaching the minimal capital ratio in non-tail risky project realizations. The results are consistent with stylized facts about pre-crisis bank behavior, and suggest implications for the optimal design of capital regulation.

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File URL: http://www.dnb.nl/en/binaries/working%20paper%20307_tcm47-256588.pdf
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Bibliographic Info

Paper provided by Netherlands Central Bank, Research Department in its series DNB Working Papers with number 307.

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Date of creation: Aug 2011
Date of revision:
Handle: RePEc:dnb:dnbwpp:307

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Web page: http://www.dnb.nl/en/
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Related research

Keywords: Banking; Capital regulation; Risk-taking; Tail risk; Systemic risk;

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References

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Citations

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Cited by:
  1. Yener Altunbas & Simone Manganelli & David Marques-Ibanez, 2012. "Bank Risk during the Financial Crisis: Do business models matter?," Working Papers 12003, Bangor Business School, Prifysgol Bangor University (Cymru / Wales).
  2. Mike Mariathasan & Ouarda Merrouche, 2012. "The Manipulation of Basel Risk-Weights. Evidence from 2007-10," Economics Series Working Papers 621, University of Oxford, Department of Economics.
  3. Maria J. Nieto & Gillian G. Garcia, 2012. "The Insufficiency of Traditional Safety Nets: What Bank Resolution Fund for Europe?," FMG Special Papers sp209, Financial Markets Group.
  4. Maria J. Nieto & Gillian G. Garcia, 2012. "The insufficiency of traditional safety nets: what bank resolution fund for Europe?," Journal of Financial Regulation and Compliance, Emerald Group Publishing, vol. 20(2), pages 116-146, May.
  5. Nataliya Klimenko, 2013. "Tailoring Bank Capital Regulation for Tail Risk," AMSE Working Papers 1310, Aix-Marseille School of Economics, Marseille, France, revised Feb 2013.
  6. Nataliya Klimenko, 2013. "Tailoring Bank Capital Regulation for Tail Risk," Working Papers halshs-00796490, HAL.

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