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The Strategic Underreporting of Bank Risk

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Listed:
  • Taylor A. Begley
  • Amiyatosh Purnanandam
  • Kuncheng Zheng

Abstract

We show that banks significantly underreport the risk in their trading book when they have lower equity capital. Specifically, a decrease in a bank’s equity capital results in substantially more violations of its self-reported risk levels in the following quarter. Underreporting is especially frequent during the critical periods of high systemic risk and for banks with larger trading operations. We exploit a discontinuity in the expected benefit of underreporting present in Basel regulations to provide further support for a causal link between capital-saving incentives and underreporting. Overall, we show that banks’ self-reported risk measures become least informative precisely when they matter the most. Received April 30, 2015; editorial decision October, 27 2016 by Editor Itay Goldstein.

Suggested Citation

  • Taylor A. Begley & Amiyatosh Purnanandam & Kuncheng Zheng, 2017. "The Strategic Underreporting of Bank Risk," Review of Financial Studies, Society for Financial Studies, vol. 30(10), pages 3376-3415.
  • Handle: RePEc:oup:rfinst:v:30:y:2017:i:10:p:3376-3415.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhx036
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    More about this item

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • 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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