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Banks Risk Race: A Signaling Explanation

  • Damien Besancenot

    ()

    (CEPN - Centre d'Economie de l'Université Paris Nord - CNRS : UMR7234 - Université Paris 13 - Université Sorbonne Paris Cité (USPC))

  • Radu Vranceanu

    ()

    (Economics Department - ESSEC Business School)

Many observers argue that the abnormal accumulation of risk by banks has been one of the major causes of the 2007-2009 nancial turmoil. But what could have pushed banks to engage in such a risk race? The answer brought by this paper builds on the classical signaling model by Spence. If banks' returns can be observed while risk cannot, less efficient banks can hide their type by taking more risks and paying the same returns as the efficient banks. The latter can signal themselves by taking even higher risks and delivering bigger returns. The game presents several equilibria that are all characterized by excessive risk taking as compared to the perfect information case.

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Paper provided by HAL in its series CEPN Working Papers with number halshs-00424214.

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Date of creation: 14 Apr 2011
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Handle: RePEc:hal:cepnwp:halshs-00424214
Note: View the original document on HAL open archive server: http://halshs.archives-ouvertes.fr/halshs-00424214
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  1. Markus K. Brunnermeier, 2009. "Deciphering the Liquidity and Credit Crunch 2007-2008," Journal of Economic Perspectives, American Economic Association, vol. 23(1), pages 77-100, Winter.
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