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The Risk Spiral: The Effects of Bank Capital and Diversification on Risk Taking

Sharon Peleg Lazar and Alon Raviv ()

MPRA Paper from University Library of Munich, Germany

Abstract: We present a model where bank assets are a portfolio of risky debt claims and analyze stockholders' risk-taking behavior while considering the strategic interaction between debtors and creditors. We find that: (1) as the leverage of a bank increases, risk shifting by borrowers increases, even if their leverage is unchanged (zombie lending). (2) While the literature demonstrates that an increase in the co-movement of a loan portfolio increases the bank's cost of default directly, we find that the increase in co-movement causes an increase in risk shifting that further increases the cost of default (3) Risk shifting decreases with the diversification of a loan portfolio.

Keywords: Risk taking; Banks; Comovements; Deposit insurance; Zombie lending (search for similar items in EconPapers)
JEL-codes: G21 G28 G32 G38 (search for similar items in EconPapers)
Date: 2019-02
New Economics Papers: this item is included in nep-ban, nep-cfn and nep-rmg
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