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Optimal bank management under capital and liquidity constraints

Author

Listed:
  • Fabian Astic

    (Moody's Investors Service, Credit Policy/Research, 7 World Trade Center at 250 Greenwich Street, NY 10007, USA)

  • Agnès Tourin

    (New York University Polytechnic School of Engineering, Department of Finance and Risk Engineering, Six MetroTech Center, Brooklyn, NY 11201, USA)

Abstract

We propose a model of a bank that invests in both liquid and illiquid assets and whose goal is to maximize its shareholders' profit while satisfying some regulatory constraints. We study the sensitivity of the shareholders' gain and optimal portfolio allocations, as well as the associated bondholders' payoff, to the minimal capital requirement and liquidity ratio. We find that tightening the liquidity constraint adversely affects their rates of return, while preventing some large losses that occur when the portfolio is very illiquid. Stiffening the minimal capital requirement penalizes the shareholders but seems to have little influence on the bondholders.

Suggested Citation

  • Fabian Astic & Agnès Tourin, 2014. "Optimal bank management under capital and liquidity constraints," Journal of Financial Engineering (JFE), World Scientific Publishing Co. Pte. Ltd., vol. 1(03), pages 1-21.
    • Handle: RePEc:wsi:jfexxx:v:01:y:2014:i:03:n:s2345768614500226
    DOI: 10.1142/S2345768614500226
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    References listed on IDEAS

    as
    1. Michael Ludkovski & Hyekyung Min, 2010. "Illiquidity Effects in Optimal Consumption-Investment Problems," Papers 1004.1489, arXiv.org, revised Sep 2010.
    2. Di Nicolo, G. & Gamba, A. & Lucchetta, M., 2011. "Capital Regulation, Liquidity Requirements and Taxation in a Dynamic Model of Banking," Other publications TiSEM 58ac9f00-92d7-497b-a76f-e, Tilburg University, School of Economics and Management.
    3. Schwartz, Eduardo S & Tebaldi, Claudio, 2004. "Illiquid Assets and Optimal Portfolio Choice," University of California at Los Angeles, Anderson Graduate School of Management qt7q65t12x, Anderson Graduate School of Management, UCLA.
    4. Michael Ludkovski & Qunying Shen, 2012. "European Option Pricing with Liquidity Shocks," Papers 1205.1007, arXiv.org.
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