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Banks’ risk race: a signaling explanation

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Author Info
Besancenot, Damien () (University Paris 13 and CEPN (Centre d'Economie de l'université Paris Nord))
Vranceanu, Radu () (ESSEC Business School, Department of Economics)

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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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Publisher 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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Find related papers by JEL classification:
D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information
G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Mortgages
G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Capital and Ownership Structure

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Jeanjean, Thomas & Cazavan-Jeny, Anne, 2005. "Levels of voluntary disclosure in IPO prospectuses : an empirical analysis," Les Cahiers de Recherche 827, HEC Paris. [Downloadable!]
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  2. Claudio Borio, 2008. "The financial turmoil of 2007-?: a preliminary assessment and some policy considerations," BIS Working Papers 251, Bank for International Settlements. [Downloadable!]
  3. Cazavan-Jeny, Anne & Jeanjean, Thomas, 2008. "Supply and demand for European accounting research. Evidence from EAA congresses," ESSEC Working Papers DR 08013, ESSEC Research Center, ESSEC Business School. [Downloadable!]
  4. Markus K. Brunnermeier, 2009. "Deciphering the Liquidity and Credit Crunch 2007-2008," Journal of Economic Perspectives, American Economic Association, vol. 23(1), pages 77-100, Winter.
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  5. Michael Spence, 2002. "Signaling in Retrospect and the Informational Structure of Markets," American Economic Review, American Economic Association, vol. 92(3), pages 434-459, June. [Downloadable!]
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  6. מחקר - ביטוח לאומי, 1900. "קרן מנוף," Working Papers 35, National Insurance Institute of Israel. [Downloadable!]
  7. Spence, A Michael, 1973. "Job Market Signaling," The Quarterly Journal of Economics, MIT Press, vol. 87(3), pages 355-74, August. [Downloadable!] (restricted)
  8. Douglas W. Diamond & Raghuram G. Rajan, 2009. "The Credit Crisis: Conjectures about Causes and Remedies," American Economic Review, American Economic Association, vol. 99(2), pages 606-10, May. [Downloadable!]
    Other versions:
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This page was last updated on 2009-12-9.

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