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Risk Averse Banks and Uncertain Correlation Values: A Theory of Rational Bank Panics

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  • Alan D. Morrison

Abstract

We present a model for Financial fragility in which banks are risk-averse portfolio managers and there is uncertainty over risk management parameters. There is a danger of heightened risk aversion and projects in small economies are assumed to be riskier than those in large economies. In this situation there is a danger that a rise in project correlations will lead to a rational but unnecessary credit crunch. We conclude firstly that greater transparency in the dissemination of correlation parameters is desirable and secondly that regulators should respond to heightened financial fragility by relaxing capital adequacy requirements.

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  • Alan D. Morrison, 2000. "Risk Averse Banks and Uncertain Correlation Values: A Theory of Rational Bank Panics," OFRC Working Papers Series 2000fe08, Oxford Financial Research Centre.
    • Handle: RePEc:sbs:wpsefe:2000fe08
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    File URL: http://www.finance.ox.ac.uk/file_links/finecon_papers/2000fe08.pdf
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    Cited by:

    1. Lundtofte, Frederik, 2015. "Banks’ pooling of corporate debt: An application of the restated diversification theorem," The North American Journal of Economics and Finance, Elsevier, vol. 31(C), pages 249-263.

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