Risk Mitigating versus Risk Shifting: Evidence from Banks Security Trading in Crises

Award Winner: 
Winner of the 2021 ECGI Finance Prize (Best paper in the Finance Working Paper series)

Risk Mitigating versus Risk Shifting: Evidence from Banks Security Trading in Crises

José-Luis Peydró, Andrea Polo, Enrico Sette, Victoria Vanasco

Series number :

Serial Number: 
713/2020

Date posted :

December 02 2020

Last revised :

March 18 2023
SSRN Share

Keywords

  • risk shifting • 
  • financial crises • 
  • securities • 
  • Bank capital • 
  • interbank funding • 
  • concentration risk • 
  • uncertainty • 
  • risk weights • 
  • available for sale • 
  • held to maturity • 
  • trading book • 
  • COVID-19.

We show that risk-mitigating incentives dominate risk-shifting incentives in fragile banks. We study security trading by banks, as banks can easily and quickly change their risk exposure within their security portfolio. For identification, we exploit different crisis shocks and supervisory ISIN-bank-month-level data.

Less capitalized banks take relatively less risk after financial stress shocks. Results hold within identical regulatory capital risk weights categories. Moreover, additional tests suggest that banks’ own incentives, rather than supervision, are the main drivers. Results hold for the different crisis shocks since 2007/08, including the COVID-19 one. A model of bank behavior rationalizes our findings.

Authors

Mr.
Real name:
José-Luis Peydró
Imperial College London/ Universitat Pompeu Fabra
Dr.
Real name:
Research Member
Luiss University, Universitat Pompeu Fabra, EIEF and Barcelona GSE
Mr.
Real name:
Enrico Sette
Bank of Italy
Real name:
Victoria Vanasco