The Theory of Bank Risk Taking and Stock Market

Document Type:Thesis

Subject Area:Business

Document 1

Early theoretical reviews on the topic Bank Risk- Taking and Stock Market are indeed fragile due to the existing risk incentive reports that discourage bank risk-taking rendering banks to be riskier as their stock markets become more concentrated. This paper, however, explores both mechanisms in literature where; on one side it describes a mechanism that operates to secure banks from the concentrated stock market. On the other side, it describes a mechanism that operates directly opposite to that and one that renders banks becoming riskier in their share markets. It includes sections of theoretical literature reviews on banks. Secondly, it constitutes the empirical literature review on banking and investment and their share markets. The paper also describes the model of a competing stock market in banking industry and lastly; it concludes by outlining the proposed model in taking care for the risk-taking mechanisms in the general banking market. Literature Review The current models in banking sector i. e. risk-taking rely highly on the insurance deposit and a few other governmental requirements that facilitates moral distortion and high competitions in the banking industry, Keenel (2014). The literature suggests that deposit cover brings about an incentive to insure on the risks. This is due to its structure where a big share goes to the shareholders and partners while large losses go to the state. However, according to Wallace (2013), this problem can be solved by providing the shareholders with responsibility in the firm highly for the incentives which are aligned to those of the bank insurer.

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Alternatively, there are two modes of implementing such a policy either by enforcing the stakeholders to have high responsibilities against their wish or by issuing them much of the stakes at will. Theoretically, Kareken and Wallace (2017) explained that for similar mechanisms to work, the insured must be bounded on a higher risk of failure resulting to less expected asset returns. A second regulatory method of giving the shareholders a highly sufficient huge stakes in the bank is presented by a scholar from the University of States, (Wiener, Antje, and Thomas Diez. According to Allen and Gale (2000), the policy allows banks to earn monopoly benefits and therefore thrive in the share market. Allen's study unveils the parameters used to determine the default risk of the banking assets. These studies usually share the assumption that optimal asset by bank allocations may be determined by sourcing the portfolio issue that takes the prices and the stock returns, (Bernstein, 2015).

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Empirical Relevance The literature reports on the relationship between the stock market and the level of banks' exposure to the risks. As showcased below, mixed findings are the result of the literature, (Seru, 2014). These studies unveil numerous specifications resulting in solid findings. Another study by De Nicolo' et. al. took an alternative approach to empirically represent the bank fragility. The competition in the banking industry which is described in relation to the variables for inflation. might respond to the growth opportunities such as population and business expansions. A difference- in- difference (DD) approach is used to compare the change in risk of banks to the change in risk of a set of banks. The Idea following the study was done by Seru (2014) and Bernstein (2014) on innovation is that a comparison between the changes of the risk of banks to a set of banks who’s private to public transition decisions was plausibly driven by the same factors.

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References Deacle, Scott, and Elyas Elyasiani. “Federal Home Loan Bank Advances and Bank and Thrift Holding Company Risk: Evidence from the Stock Market. “Bank Governance Structures and Risk Taking. ” Jan. doi: 10. Hamid, Fazelina Sahul, and Norhanishah Mohd Yunus. “Market Discipline and Bank Risk Taking: Evidence from the East Asian Banking Sector. doi:10. b978-0-12-803438-5. Owyang, Michael T. and Hannah Shell. “Taking Stock: Income Inequality and the Stock Market. Taking Stock of Integration Theory. ” Politics Trove, 2017, doi:10. help/9780199226092. Literature Matrix Literature Review Study Summaries Author Aim Frame- work Sample Design Variables Results Controversies Limitations Implications Falato, A. Scharfstein, D. Lack of enough evidence. High interdependence between the stock market and banks Deacle, Scott, and Elyas Elyasiani. To determine the correlation. Stock market and Risk-taking 400 banks in New York Random design Risk and share market The two are related.

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This study differs in ideology. Stock market and Risk-taking 150 banks in India Random design Risk and share market The two are related. This study differs in ideology. Does not give enough evidence. High correlation between the variable. Hamid, Fazelina Sahul, and Norhanishah Mohd Yunus. High correlation between the variable. Owyang, Michael T. and Hannah Shell To determine the correlation. Stock market and Risk-taking 300 banks in USA Random design Risk and share market The two are related. This study differs in ideology.

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