Risk-Taking Behaviour With Expected Utility and Limited Liability: Applications to the Regulation of Financial Intermediaries
We examine the optimal risk-taking behaviour of a risk-averse individual under the assumption of a guaranteed floor for wealth (limited liability). We show that the existence of limited liability raises the optimal exposure to risk. Also, there is a positive lower bound to initial wealth (equity) under which it is optimal to accept the maximum allowed risk (''betting for ressurection''). An exogenous increase in equity does not necessarily reduces optimal exposure to risk, except if absolute risk aversion is non- decreasing. In particular, we show that increasing equity capital would increase the probability of failure if relative risk aversion is decreasing. Applications are for the regulation of the banking and insurance systems with incomplete markets and asymmetric information.
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- 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 309-319, May.
- Dionne, G. & Eeckhoudt, L., 1990. "Increases in Risk and Linear Payoffs," Cahiers de recherche 9019, Universite de Montreal, Departement de sciences economiques.
- Dionne, G. & Eeckhoudt, L., 1990. "Increases In Risk And Linear Payoffs," Cahiers de recherche 9019, Centre interuniversitaire de recherche en économie quantitative, CIREQ.
- Rochet, Jean-Charles, 1992. "Capital requirements and the behaviour of commercial banks," European Economic Review, Elsevier, vol. 36(5), pages 1137-1170, June.
- Gollier Christian, 1995. "The Comparative Statics of Changes in Risk Revisited," Journal of Economic Theory, Elsevier, vol. 66(2), pages 522-535, August.
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