How Do Risky Banks Finance Their Assets?

By Duran, Miguel A.; Lozano-Vivas, Ana | International Advances in Economic Research, November 2012 | Go to article overview

How Do Risky Banks Finance Their Assets?


Duran, Miguel A., Lozano-Vivas, Ana, International Advances in Economic Research


JEL G20

Our aim is to empirically analyze the moral hazard conflict between banks' stock and debt holders. For this conflict to arise in a bank, two ingredients are necessary: a decreasing capital ratio (i.e., increasing leverage) and a worsening of the risk position. If these two ingredients are present, stakeholders would be reducing their exposure to risk at the expense of debt holders. That is, the former would be transferring risk to the latter. The incentives for risk shifting lie in the fact that the bank's equity has the payoff structure of a call option over the bank's value. Therefore, higher risk increases the upside potential for stockholders, whereas debt holders bear most of the downside risk.

To study this moral hazard problem, we split banks' financial structures into equity, deposits, and other funding sources. This makes it possible to find out not only whether risk shifting exists, but also to whom risk is being transferred. Indeed, we put forward a taxonomy of moral hazard based on the type of debt holders to whom risk is being transferred.

Our econometric model extends that of Shrieves and Dahl (The Relationship between Risk and Capital in Commercial Banks, Journal of Banking and Finance, vol. 16). This allows us to take into account the relationship not only between changes in risk and the assets-to-equity ratio, but also between changes in risk and in any of the ratios of the three funding sources considered. Accordingly, we use three simultaneous systems of two equations where the observed changes in risk and in the ratios of the three funding sources considered are assumed to have two components: a discretionary component and an exogenous, random, independent and identically distributed (iid) shock. The discretionary component is modeled as a partial adjustment process. That is, this component is proportional to the difference between the target value and the value in the previous period of either risk or the ratio of the funding source considered. Since target values are not observed, they are defined as a linear function that depends on the size, profitability, and capital buffer of banks, and on a set of regulatory variables.

The rest of this article is only available to active members of Questia

Sign up now for a free, 1-day trial and receive full access to:

  • Questia's entire collection
  • Automatic bibliography creation
  • More helpful research tools like notes, citations, and highlights
  • Ad-free environment

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Project items

Items saved from this article

This article has been saved
Highlights (0)
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

Citations (0)
Some of your citations are legacy items.

Any citation created before July 30, 2012 will labeled as a “Cited page.” New citations will be saved as cited passages, pages or articles.

We also added the ability to view new citations from your projects or the book or article where you created them.

Notes (0)
Bookmarks (0)

You have no saved items from this article

Project items include:
  • Saved book/article
  • Highlights
  • Quotes/citations
  • Notes
  • Bookmarks
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited article

How Do Risky Banks Finance Their Assets?
Settings

Settings

Typeface
Text size Smaller Larger
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Full screen

matching results for page

Cited passage

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited passage

Welcome to the new Questia Reader

The Questia Reader has been updated to provide you with an even better online reading experience.  It is now 100% Responsive, which means you can read our books and articles on any sized device you wish.  All of your favorite tools like notes, highlights, and citations are still here, but the way you select text has been updated to be easier to use, especially on touchscreen devices.  Here's how:

1. Click or tap the first word you want to select.
2. Click or tap the last word you want to select.

OK, got it!

Thanks for trying Questia!

Please continue trying out our research tools, but please note, full functionality is available only to our active members.

Your work will be lost once you leave this Web page.

For full access in an ad-free environment, sign up now for a FREE, 1-day trial.

Already a member? Log in now.