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Annals of Finance

, Volume 15, Issue 3, pp 369–399 | Cite as

Optimal bailouts, bank’s incentive and risk

  • Marcella LucchettaEmail author
  • Michele Moretto
  • Bruno M. Parigi
Research Article
  • 63 Downloads

Abstract

We show how the impact of a government bailout in the form of liquidity assistance on the ex ante effort of a representative bank depends on the volatility of its investment. The bank’s investment delivers a cashflow that follows a geometric Brownian motion and the government guarantees the bank’s liabilities. To counter the bank’s expectations of a bailout, the government may choose a tighter liquidity policy when the bank’s effort is not observable. This tighter liquidity induces more prudent ex ante behavior by the bank, but it may have the opposite effect when investment volatility is high. This novel effect arises because the bank could be discouraged to be prudent precisely because the chances of receiving liquidity assistance are low.

Keywords

Liquidity assistance Bank closure Real option 

JEL Classification

G00 G20 G21 

Notes

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Copyright information

© Springer-Verlag GmbH Germany, part of Springer Nature 2019

Authors and Affiliations

  1. 1.University of VeniceVeniceItaly
  2. 2.University of PadovaPaduaItaly
  3. 3.CESifoMunichGermany

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