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Risk and regret aversions on optimal bank interest margin under capital regulation

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  • Tsai, Jeng-Yan

Abstract

This paper examines the bank's optimal loan rate (and thus the bank's interest margin) under more stringent capital regulation when the bank is not only risk-averse but also regret-averse. Risk-averse preferences are characterized by an option-based utility function that includes disutility from the dislike of bank equity risk. Regret-averse preferences feature an option-based utility function that includes disutility from having chosen ex-post suboptimal alternatives. We show that an increase in bank capital requirement results in an increased margin under risk aversion dominating regret aversion, whereas it results in a reduced margin under regret aversion dominating risk aversion. The former holds when risk aversion domination stems from increasing risk-averse preference, but not from decreasing regret-averse preference, while the latter holds when regret aversion domination results from either decreasing risk-averse or increasing regret-averse preference. Risk aversion, as such, makes the bank more prudent and less prone to risk-taking, while regret aversion, as such, makes the bank less prudent and more prone to risk-taking.

Suggested Citation

  • Tsai, Jeng-Yan, 2012. "Risk and regret aversions on optimal bank interest margin under capital regulation," Economic Modelling, Elsevier, vol. 29(6), pages 2190-2197.
  • Handle: RePEc:eee:ecmode:v:29:y:2012:i:6:p:2190-2197
    DOI: 10.1016/j.econmod.2012.06.028
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    References listed on IDEAS

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    Cited by:

    1. Wong, Kit Pong, 2014. "Fixed versus variable rate loans under regret aversion," Economic Modelling, Elsevier, vol. 42(C), pages 140-145.
    2. Fujii, Yoichiro & Okura, Mahito & Osaki, Yusuke, 2016. "Regret, rejoicing, and mixed insurance," Economic Modelling, Elsevier, vol. 58(C), pages 126-132.
    3. Chen, Shi & Chang, Chuen-Ping, 2015. "Should bank loan portfolio be diversified under government capital injection and deposit insurance fund protection?," International Review of Economics & Finance, Elsevier, vol. 38(C), pages 131-141.
    4. Martín Egozcue & Xu Guo & Wing-Keung Wong, 2015. "Optimal output for the regret-averse competitive firm under price uncertainty," Eurasian Economic Review, Springer;Eurasia Business and Economics Society, vol. 5(2), pages 279-295, December.
    5. Wong, Kit Pong, 2013. "Fixed versus variable rate loans under state-dependent preferences," Economic Modelling, Elsevier, vol. 31(C), pages 659-663.
    6. Chang, Chuen-Ping & Chen, Shi, 2016. "Government capital injection, credit risk transfer, and bank performance during a financial crisis," Economic Modelling, Elsevier, vol. 53(C), pages 477-486.
    7. Niu, Cuizhen & Guo, Xu & Wang, Tao & Xu, Peirong, 2014. "Regret theory and the competitive firm: A comment," Economic Modelling, Elsevier, vol. 41(C), pages 312-315.
    8. Chen, Shi & Lin, Ku-Jun, 2016. "Effects of government capital injection on bank and bank-dependent borrower," Economic Modelling, Elsevier, vol. 52(PB), pages 618-629.
    9. Lin, Jyh-Horng & Hung, Wei-Ming, 2013. "A barrier option framework for bank interest margin management under anticipatory regret aversion," Economic Modelling, Elsevier, vol. 33(C), pages 794-801.
    10. Guo, Xu & Wong, Wing-Keung & Xu, Qunfang & Zhu, Xuehu, 2015. "Production and hedging decisions under regret aversion," Economic Modelling, Elsevier, vol. 51(C), pages 153-158.
    11. Tsai, Jeng-Yan, 2013. "Bank interest margin management based on a path-dependent Cobb–Douglas utility framework," Economic Modelling, Elsevier, vol. 35(C), pages 751-762.
    12. Chang, Chuen-Ping, 2014. "A barrier option framework for rescue package designs and bank default risks," Economic Modelling, Elsevier, vol. 38(C), pages 246-257.

    More about this item

    Keywords

    Interest margin; Capital regulation; Regret aversion; Risk aversion;

    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

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