Destructive Agents, Finance Firms, and Systemic Risk

Natasa Bilkic () and Thomas Gries
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Natasa Bilkic: University of Paderborn

No 76, Working Papers CIE from Paderborn University, CIE Center for International Economics

Abstract: Popular opinion suggests that malfunctioning, poorly designed incentive schemes in financial firms that encouraged greed and involved excessive salaries were responsible for the excessive risk taking that eventually led to the 2008 financial crash. In this paper we discuss this claim in a theoretical model. We use a modified version of delegated portfolio choice approach with performance contracts. If, in this modified model, we allow for the existence of destructive agents - when maximizing their private utility - each financial firm will take excessive risks. As a result the finance sector develops systemic risk. We define systemic risk as inefficient and excessive risk that is chosen in an endogenous and stable manner by the aggregate market.

Keywords: delegated portfolio choice; systemic risk; destructive agent; adverse selection (search for similar items in EconPapers)
JEL-codes: D82 D86 G14 (search for similar items in EconPapers)
Pages: 30 pages
Date: 2014-02
New Economics Papers: this item is included in nep-cta
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Citations: View citations in EconPapers (1)

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