The impact of write-down equity on bank stability under ambiguity aversion

Zhiming Zhao, Lingyan Qiu and Jianping Shu

International Review of Economics & Finance, 2025, vol. 98, issue C

Abstract: This study quantifies the impact of write-down equity (WDE) on bank stability and risk-taking incentives under ambiguity aversion. We decompose payoffs to bank stakeholders into sets of barrier options and present closed-form solutions for their prices. Our paper shows that: first, write-down equity plays an important role in eliminating managerial risk-taking incentives: a 1% increase in write-down ratio reduces the managerial optimal risk level by 0.2%. Second, WDE has double effect of equity incentives and penalties. With low leverage ratio, risk-taking incentives dominate while the write-down ratio falls below 0.51. Third, ambiguity-averse managers are more conservative resulting in lower banking default probability. Meanwhile, as ambiguity increasing policy makers should implement a higher write-down ratio to stabilize banks.

Keywords: Write-down equity; Risk taking; Ambiguity aversion; Financial stability (search for similar items in EconPapers)
JEL-codes: G11 G14 G32 (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:reveco:v:98:y:2025:i:c:s1059056025000140

DOI: 10.1016/j.iref.2025.103851

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