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Banks’ risk race: a signaling explanation

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  • Besancenot, Damien

    ()
    (University Paris 13 and CEPN (Centre d'Economie de l'université Paris Nord))

  • Vranceanu, Radu

    ()
    (ESSEC Business School, Department of Economics)

Abstract

Many observers argue that the abnormal accumulation of risk by banks has been one of the major causes of the 2007-2009 financial turmoil. But what could have pushed banks to engage in such a risk race? The answer brought by this paper builds on the classical signaling model by Spence. If banks’ returns can be observed while risk cannot, less efficient banks can hide their type by taking more risks and paying the same returns as the efficient banks. The latter can signal themselves by taking even higher risks and delivering bigger returns. The game presents several equilibria that are all characterized by excessive risk taking as compared to the perfect information case.

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Bibliographic Info

Paper provided by ESSEC Research Center, ESSEC Business School in its series ESSEC Working Papers with number DR 09007.

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Length: 12 pages
Date of creation: Oct 2009
Date of revision:
Handle: RePEc:ebg:essewp:dr-09007

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Postal: ESSEC Research Center, BP 105, 95021 Cergy, France
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Web page: http://www.essec.edu/
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Related research

Keywords: Banking Sector; Imperfect Information; Risk Strategy; Risk/return Tradeoff; Signaling;

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  1. Vranceanu, Radu & Sutan, Angela & Dubart, Delphine, 2010. "Trust and Financial Trades: Lessons from an Investment Game Where Reciprocators Can Hide Behind Probabilities," ESSEC Working Papers DR 10007, ESSEC Research Center, ESSEC Business School.
  2. Spence, A Michael, 1973. "Job Market Signaling," The Quarterly Journal of Economics, MIT Press, vol. 87(3), pages 355-74, August.
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  8. Vranceanu, Radu & Laot, Maxime & Dubart, Delphine, 2010. "Une échelle de mesure de la connaissance en raisonnement économique et résultats d'une enquête menée en décembre 2009," ESSEC Working Papers DR 10001, ESSEC Research Center, ESSEC Business School.
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Cited by:
  1. repec:hal:wpaper:halshs-00602107 is not listed on IDEAS
  2. Besancenot, Damien & Huynh, Kim & Vranceanu, Radu, 2009. "Desk rejection in an academic publication market model with matching frictions," ESSEC Working Papers DR 09008, ESSEC Research Center, ESSEC Business School.
  3. Vranceanu, Radu & Besancenot, Damien, 2011. "Experimental Evidence on the ‘Insidious’ Illiquidity Risk," ESSEC Working Papers WP1107, ESSEC Research Center, ESSEC Business School.
  4. repec:cge:warwcg:75 is not listed on IDEAS

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