Optimal bank management under capital and liquidity constraints

Fabian Astic () and Agnès Tourin ()
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Fabian Astic: Moody's Investors Service, Credit Policy/Research, 7 World Trade Center at 250 Greenwich Street, NY 10007, USA
Agnès Tourin: New York University Polytechnic School of Engineering, Department of Finance and Risk Engineering, Six MetroTech Center, Brooklyn, NY 11201, USA

Journal of Financial Engineering (JFE), 2014, vol. 01, issue 03, 1-21

Abstract: We propose a model of a bank that invests in both liquid and illiquid assets and whose goal is to maximize its shareholders' profit while satisfying some regulatory constraints. We study the sensitivity of the shareholders' gain and optimal portfolio allocations, as well as the associated bondholders' payoff, to the minimal capital requirement and liquidity ratio. We find that tightening the liquidity constraint adversely affects their rates of return, while preventing some large losses that occur when the portfolio is very illiquid. Stiffening the minimal capital requirement penalizes the shareholders but seems to have little influence on the bondholders.

Keywords: Optimal stochastic control; financial regulations; bank optimal management; free boundary problem; monotone Finite Difference scheme (search for similar items in EconPapers)
Date: 2014
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DOI: 10.1142/S2345768614500226

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