Banks’ risk race: a signaling explanation

Damien Besancenot and Radu Vranceanu

No DR 09007, ESSEC Working Papers from ESSEC Research Center, ESSEC Business School

Abstract: Many observers argue that the abnormal accumulation of risk by banks has been one of the major causes of the 2007-2009 financial 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.

Keywords: Banking Sector; Imperfect Information; Risk Strategy; Risk/return Tradeoff; Signaling (search for similar items in EconPapers)
JEL-codes: D82 G21 G32 (search for similar items in EconPapers)
Pages: 12 pages
Date: 2009-10
New Economics Papers: this item is included in nep-ban, nep-cta and nep-fmk
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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Related works:
Journal Article: Banks' risk race: A signaling explanation (2011)
Working Paper: Banks risk race: A signaling explanation (2011)
Working Paper: Banks' risk race: A signaling explanation (2010)
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