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Destructive Agents, Finance Firms, and Systemic Risk

Author

Listed:
  • Natasa Bilkic

    (University of Paderborn)

  • Thomas Gries

    (University of Paderborn)

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.

Suggested Citation

  • Natasa Bilkic & Thomas Gries, 2014. "Destructive Agents, Finance Firms, and Systemic Risk," Working Papers CIE 76, Paderborn University, CIE Center for International Economics.
    • Handle: RePEc:pdn:ciepap:76
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    File URL: http://groups.uni-paderborn.de/wp-wiwi/RePEc/pdf/ciepap/WP76.pdf
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    References listed on IDEAS

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    Cited by:

    1. Chukwudi Henry Dike, 2020. "Strategic Interactions in Financial Networks," 2020 Papers pdi579, Job Market Papers.

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    More about this item

    Keywords

    delegated portfolio choice; systemic risk; destructive agent; adverse selection;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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