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Are bank shareholders enemies of regulators or a potential source of market discipline?

  • Sangkyun Park
  • Stavros Peristiani

In moral hazard models, bank shareholders have incentives to transfer wealth from the deposit insurer--that is, maximize put option value--by pursuing riskier strategies. For safe banks with large charter value, however, the risk-taking incentive is outweighed by the possibility of losing charter value. Focusing on the relationship between book value, market value, and a risk measure, this paper develops a semi-parametric model for estimating the critical level of bank risk at which put option value starts to dominate charter value. From these estimates, we infer the extent to which the risk-taking incentive prevailed during 1986-92, a period characterized by serious banking problems and financial turmoil. We find that despite the difficult financial environment, shareholders' risk-taking incentive was confined primarily to a small fraction of highly risky banks.

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Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 138.

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Date of creation: 2001
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Handle: RePEc:fip:fednsr:138
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  16. Sangkyun Park & Stavros Peristiani, 2001. "Are bank shareholders enemies of regulators or a potential source of market discipline?," Staff Reports 138, Federal Reserve Bank of New York.
  17. Brewer, Elijah, III & Mondschean, Thomas H, 1994. "An Empirical Test of the Incentive Effects of Deposit Insurance: The Case of Junk Bonds at Savings and Loan Associations," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 26(1), pages 146-64, February.
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