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Social Welfare Analysis in a Financial Economy with Risk Regulation
Author(s) -
VICENTE JOSÉ,
ARAÚJO ALOÍSIO
Publication year - 2010
Publication title -
journal of public economic theory
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.809
H-Index - 32
eISSN - 1467-9779
pISSN - 1097-3923
DOI - 10.1111/j.1467-9779.2010.01464.x
Subject(s) - economics , risk appetite , financial fragility , soundness , institution , control (management) , welfare , financial institution , financial market , fragility , financial risk , social welfare , finance , market economy , macroeconomics , financial crisis , risk management , linguistics , philosophy , chemistry , management , political science , law
In the last years, regulating agencies of many countries in the world have adopted VaR‐based risk regulation to control market risk of financial institutions. This paper investigates the consequences of such kind of regulation to social welfare and soundness of financial institutions through an equilibrium model. We show that the optimum level of regulation for each financial institution (the level that maximizes its utility) depends on its appetite for risk and that some of them can perform better in a regulated economy. In addition, another important result asserts that under certain market conditions the financial fragility of an institution can be greater in a regulated economy than in an unregulated one.