Competition for traders and risk

Jan Boone and Gijsbert Zwart

No 8816, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: The financial crisis has been attributed partly to perverse incentives for traders at banks and has led policy makers to propose regulation of banks' remuneration packages. We explain why poor incentives for traders cannot be fully resolved by only regulating the bank's top executives, and why direct intervention in trader compensation is called for. We present a model with both trader moral hazard and adverse selection on trader abilities. We demonstrate that as competition on the labour market for traders intensifies, banks optimally offer top traders contracts inducing them to take more risk, even if banks fully internalize the costs of negative outcomes. In this way, banks can reduce the surplus they have to offer to lower ability traders. In addition, we find that increasing banks' capital requirements does not unambiguously lead to reduced risk-taking by their top traders.

Keywords: Financial institutions; Imperfect competition; Optimal contracts; Remuneration policy; Risk (search for similar items in EconPapers)
JEL-codes: G21 G32 L22 (search for similar items in EconPapers)
Date: 2012-02
New Economics Papers: this item is included in nep-cta
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Citations: View citations in EconPapers (11)

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Related works:
Journal Article: Competition for traders and risk (2018)
Working Paper: Competition for traders and risk (2012)
Working Paper: Competition for Traders and Risk (2012)
Working Paper: Competition for Traders and Risk (2012)
Working Paper: Competition for Traders and Risk (2012)
Working Paper: Competition for Traders and Risk (2012)
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