RISK TAKING, SECURITIZATION AND THE OPTION TO CHANGE STRATEGY

This paper analyzes the risk-taking behavior of financial intuitions that have guarantees and/or institutions that find it beneficial to develop a reputation for not taking risk. It focuses on two questions: Is it rational for them to take on less risk than they can get away with, and if it is rational, under what conditions will they shift strategies and increase their risk? To answer the question we allow for future benefits from survival in the form of ífranchise value.î With franchise value they might take less risk than they are allowed; however, if they experience large enough negative shocks, they reach a tipping point where they will change their strategy discontinuously, and ígamble for resurrection.î For instance, a decline in franchise due to increased competition can lead to abrupt changes in risk-taking. This is a possible explanation for changes in quality of pools of securitized loans. Similarly a decline capital can lead financial institutions ramp up risk-taking.