Banks' risk race: A signaling explanation

Radu Vranceanu and Damien Besancenot

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Abstract: Many observers argue that the abnormal accumulation of risk by banks has been one of the major causes of the 2007-2009 financial turmoil. But what could have pushed banks to engage in such a risk race? The answer brought by this paper builds on the classical signaling model by Spence. If banks' returns can be observed while risk cannot, less efficient banks can hide their type by taking more risks and paying the same returns as the efficient banks. The latter can signal themselves by taking even higher risks and delivering bigger returns. The game presents several equilibria that are all characterized by excessive risk taking as compared to the perfect information case.

Keywords: Banking Sector; Imperfect Information; Risk Strategy; Risk/return Tradeoff; Signaling; Arbitrage risque/rendement; Information imparfaite; Secteur bancaire; Signalisation; Stratégie de risque (search for similar items in EconPapers)
Date: 2010-06
Note: View the original document on HAL open archive server: https://essec.hal.science/hal-00554719
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Published in 2010

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Related works:
Journal Article: Banks' risk race: A signaling explanation (2011)
Working Paper: Banks risk race: A signaling explanation (2011)
Working Paper: Banks’ risk race: a signaling explanation (2009)
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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-00554719

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