Working Paper: CEPR ID: DP13734
Authors: Bart Lambrecht; Alex Tse
Abstract: We present a dynamic, continuous-time model in which risk averse inside equityholders set a bank's lending, payout, and financing policies, and the exposure of bank assets to crashes. We study how the prevailing insolvency resolution mechanism affects these policies, the insolvency rate, loss in default, value at risk (VaR), and the net value created by the bank. VaR depends non-trivially on jump (crash) risk, diffusion risk and the horizon. We examine the commonplace assertion that bailouts encourage excessive lending and risk-taking compared to the liquidation and bail-in regimes, and explore whether bailouts could be financed by banks without taxpayers' money.
Keywords: liquidation; bailout; bail-in; asset sale; agency
JEL Codes: G33; H81; G34; G32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| bailout regime (G28) | excessive risk-taking (G41) |
| liquidation regime (G33) | lowest risk-taking (D81) |
| liquidation regime (G33) | lowest insolvency rates (G33) |
| bailout regime (G28) | highest insolvency rates (G33) |
| moral hazard under liquidation (G33) | low-quality loans (G21) |
| bail-ins (G28) | lowest loan issuance (G51) |
| bail-ins (G28) | highest quality of loans (G21) |
| bail-in regime (G28) | minimizes VaR (C29) |
| bailout regime (G28) | highest VaR (C29) |