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Banks' risk race: A signaling explanation

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Author Info

  • Radu Vranceanu

    ()
    (Economics Department - ESSEC Business School)

  • Damien Besancenot

    ()
    (CEPN - Centre d'économie de l'Université de Paris Nord - CNRS : UMR7115 - Université Paris-Nord - Paris XIII)

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 HAL in its series Post-Print with number hal-00554719.

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Date of creation: Jun 2010
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Handle: RePEc:hal:journl:hal-00554719

Note: View the original document on HAL open archive server: http://hal-essec.archives-ouvertes.fr/hal-00554719/en/
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Related research

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

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References

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  1. Vranceanu, Radu, 2009. "Four Myths and a Financial Crisis," ESSEC Working Papers DR 09006, ESSEC Research Center, ESSEC Business School.
  2. Riley, John G., 1975. "Competitive signalling," Journal of Economic Theory, Elsevier, vol. 10(2), pages 174-186, April.
  3. Radu Vranceanu & Angela Sutan & Delphine Dubart, 2011. "Trust and financial trades : lessons from an investment game wher reciprocators can hide behind probabilities," Post-Print hal-00572384, HAL.
  4. 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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  17. Haslem, John A. & Scheraga, Carl A. & Bedingfield, James P., 1999. "DEA efficiency profiles of U.S. banks operating internationally," International Review of Economics & Finance, Elsevier, vol. 8(2), pages 165-182, June.
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Citations

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Cited by:
  1. Damien Besancenot & Radu Vranceanu, 2011. "Experimental Evidence on the 'Insidious' Illiquidity Risk," Post-Print hal-00607867, HAL.
  2. Radu Vranceanu & Damien Besancenot & Kim Huynh, 2009. "Desk rejection in an academic publication market model with matching frictions," Post-Print hal-00554732, HAL.
  3. Proto, Eugenio & Sgroi, Daniel, 2012. "Self-Centered Beliefs : An Empirical Approach," The Warwick Economics Research Paper Series (TWERPS) 978, University of Warwick, Department of Economics.
  4. Damien Besancenot & Radu Vranceanu, 2011. "Experimental Evidence On The 'Insidious' Illiquidity Risk," Working Papers halshs-00602107, HAL.

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