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Risk-Taking Behavior with Limited Liability and Risk Aversion

  • Christian Gollier
  • Pierre-François Koehl
  • Jean-Charles Rochet

The authors of this paper consider the problem of a risk-averse firm with limited liability. The firm has to select the size of its investment in a risky project. We show that the optimal exposure to risk of the limited liability firm is always larger than under full liability. Moreover, there exists a positive lower bound on the value of the firm below which the firm will "bet for resurrection," i.e. it will invest the largest positive amount in the risky project. We also consider the standard portfolio problem with more than one risky asset. We show that limited liability may induce the firm to specialize in no Mean-Variance efficient assets. This paper was presented at the Financial Institutions Center's May 1996 conference on "

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File URL: http://fic.wharton.upenn.edu/fic/papers/96/9613.pdf
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Paper provided by Wharton School Center for Financial Institutions, University of Pennsylvania in its series Center for Financial Institutions Working Papers with number 96-13.

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Date of creation: May 1996
Date of revision:
Handle: RePEc:wop:pennin:96-13
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  1. Dionne, Georges & Eeckhoudt, Louis & Gollier, Christian, 1993. "Increases in Risk and Linear Payoffs," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 34(2), pages 309-19, May.
  2. Rochet, Jean-Charles, 1992. "Capital requirements and the behaviour of commercial banks," European Economic Review, Elsevier, vol. 36(5), pages 1137-1170, June.
  3. Gollier Christian, 1995. "The Comparative Statics of Changes in Risk Revisited," Journal of Economic Theory, Elsevier, vol. 66(2), pages 522-535, August.
  4. Golbe, Devra L., 1988. "Risk-taking by firms near bankruptcy," Economics Letters, Elsevier, vol. 28(1), pages 75-79.
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