Risk Management Failures
McGill University - Desautels Faculty of Management
Santa Clara University - Leavey School of Business; European Corporate Governance Institute (ECGI)
September 1, 2015
Paris December 2015 Finance Meeting EUROFIDAI - AFFI
European Corporate Governance Institute (ECGI) - Finance Working Paper No. 454/2015
Abstract:
We present a model in which firms are engaged in preemptive competition for trading opportunities and the cost of risk management increases with time pressure in financial markets. Because time pressure is in turn endogenous to risk management choices, strategic complementarities can trigger a race to the bottom: firms' decisions to abandon risk management, while individually rational, are constrained inefficient, and cause a misallocation of risks among financial intermediaries. Externalities operate through opportunity costs and agency costs, and provide a rationale for regulation that views risk management both as a coordination problem (among firms) and as a governance problem (inside firms).
Number of Pages in PDF File: 80
Keywords: Banks, Risk Management, Time Pressure, Delegated Trading, Coordination Failure, Global Games
JEL Classification: G20, G21, G28
