Can Limited Liability Increase Stability for Banks: A Dynamic Portfolio Approach

Deb Narayan Barik and Siddhartha P. Chakrabarty

Papers from arXiv.org

Abstract: We present a novel approach for the bank's decision problem, incorporating Limited Liability in the objective function. Accordingly, we consider continuous time models, with and without Limited Liability. We compare the solutions of these two models to demonstrate the effect of inclusion of Limited Liability. To solve the problem with the objective function incorporating Limited Liability, we approximate the payoff function to another set of functions for which we have closed-form solutions. Then, we show that the solution with Limited Liability incorporates less risky assets, while simultaneously increasing the resilience of the bank. After that, we use the metric of $Distance~to~Default$, from the KMV Model, to analyze the bank's resiliency, by considering that the interest rate follows the Vasicek model. Finally, we illustrate the results obtained with a numerical example.

Date: 2025-07
References: Add references at CitEc
Citations:

Downloads: (external link)
http://arxiv.org/pdf/2507.16494 Latest version (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:arx:papers:2507.16494

Access Statistics for this paper

More papers in Papers from arXiv.org
Bibliographic data for series maintained by arXiv administrators ().