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

  • Tsai, Jeng-Yan
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    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.

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    File URL: http://www.sciencedirect.com/science/article/pii/S0264999312002015
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    Article provided by Elsevier in its journal Economic Modelling.

    Volume (Year): 29 (2012)
    Issue (Month): 6 ()
    Pages: 2190-2197

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    Handle: RePEc:eee:ecmode:v:29:y:2012:i:6:p:2190-2197
    Contact details of provider: Web page: http://www.elsevier.com/locate/inca/30411

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