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Banks’ optimal implementation strategies for a risk sensitive regulatory capital rule: a real options and signalling approach

Kjell Bjørn Nordal

No 2006/12, Working Paper from Norges Bank

Abstract: I evaluate a bank's incentives to implement a risk sensitive regulatory capital rule and to invest in improved risk measurement. The decision making is analyzed within a real options framework where optimal policies are derived in terms of threshold levels of risk. I also evaluate the situation where exercise or non-exercise of the options to implement or invest are signals about the underlying quality of the loan portfolio. The framework is used for a numerical evaluation of banks' decision of whether to use internal rating based models for credit risk (the IRB-approach) under the new Basel accord (Basel II), where the dynamic behavior of risk is described by an Ohrnstein-Uhlenbeck process. I discuss empirical implications of the evaluation framework.

Keywords: Risk measurement; capital structure; real options; Basel II (search for similar items in EconPapers)
JEL-codes: G13 G21 G28 G32 (search for similar items in EconPapers)
Pages: 36 pages
Date: 2006-12-11
New Economics Papers: this item is included in nep-ban, nep-cfn, nep-reg and nep-rmg
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