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Capital Regulation and Tail Risk

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Listed:
  • Perotti, Enrico
  • Ratnovski, Lev
  • Vlahu, Razvan

Abstract

The paper studies risk mitigation associated with capital regulation, in a context where banks may choose tail risk assets. We show that this undermines the traditional result that higher capital reduces excess risk-taking driven by limited liability. Moreover, higher capital may have an unintended e¤ect of enabling banks to take more tail risk without the fear of breaching the minimal capital ratio in nontail risky project realizations. The results are consistent with stylized facts about pre-crisis bank behavior, and suggest implications for the optimal design of capital regulation.

Suggested Citation

  • Perotti, Enrico & Ratnovski, Lev & Vlahu, Razvan, 2011. "Capital Regulation and Tail Risk," CEPR Discussion Papers 8526, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:8526
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    More about this item

    Keywords

    Capital regulation; Keywords: banking; Risk; Risk-taking; Systemic risk; Tail risk;
    All these keywords.

    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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