Excessive bank risk-taking in an infinite horizon economy

Pozo J. · Journal of Financial Stability (2024) · DOI: 10.1016/j.jfs.2024.101263

Resumen

We develop a dynamic framework to study banks’ incentives to take excessive risk in an emerging economy, where bank default probability and excess bank risk-taking are modeled endogenously. We calibrate it for the 1998 Peruvian economy. We find that the infinite-period feature amplifies banks’ incentives to take excessive risk. When we simulate the sudden stop that hit Peru in 1998, the model accurately predicts the substantial short-term rise in the non-performing loans ratio through the rise of the bank default probability.

Instituciones: Pontificia Universidad Católica del Perú