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We analyze the impact of the Volcker Rule on a bank's earnings and default probability by using a stochastic control model where the bank maximizes its value by selecting an optimal dividend, recapitalization, and investment strategy. We calibrate the model to a sample of U.S. banks. Since the Volcker Rule decreases the trading book size and this way raises the illiquid banking book portfolio that is more difficult to control, our calibrated model implies that the rule raises the banks' default probability.

The Impact of Volcker Rule on Bank Profits and Default Probabilities