The dynamics of a banking duopoly with capital regulations
We analyse the dynamics of a banking duopoly game with heterogeneous players (as regards the type of expectationsâ€™ formation), to investigate the effects of the capital requirements introduced by international accords (Basel-I in 1988 and more recently Basel-II and Basel-III), in the context of the Monti-Klein model. This analysis reveals that the policy of introducing a capital requirement may stabilise the market equilibrium. Moreover, we show that when the capital standard is reduced the market stability is lost through a flip bifurcation and subsequently a cascade of flip bifurcations may lead to periodic cycles and chaos. Therefore, although on the one side the capital regulation is harmful for the equilibrium loansâ€™ volume and profit, on the other side it is effective in keeping or restoring the stability of the Cournot-Nash equilibrium in the banking duopoly.
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