The paper studies risk mitigation associated with capital regulation, in a context where banks may choose tail risk asserts. We show that this undermines the traditional result that high capital reduces excess risk-taking driven by limited liability. Moreover, higher capital may have an...

The Basel framework has produced complex definitions of “adequate” capital, expressed in terms of book (accounting) ratios. However, solvency actually depends not on accounting ratios but on private investors' valuation of the firm's assets' and liabilities' market values. At large banking...

Can the risk of losses upon premature liquidation produce bank runs? We show how a unique run equilibrium driven by asset liquidity risk arises even under minimal fundamental risk. To study the role of illiquidity we introduce realistic norms on bank default, such that mandatory stay is...