Competition for Traders and Risk

M. Bijlsma, J. Boone, Gijsbert Zwart

Research output: Working paperDiscussion paperOther research output

254 Downloads (Pure)

Abstract

Abstract: The financial crisis has been attributed partly to perverse incentives for traders at banks and has led policy makers to propose regulation of banks’ remuneration packages. We explain why poor incentives for traders cannot be fully resolved by only regulating the bank’s top executives, and why direct intervention in trader compensation is called for. We present a model with both trader moral hazard and adverse selection on trader abilities. We demonstrate that as competition on the labour market for traders intensifies, banks optimally offer top traders contracts inducing them to take more risk, even if banks fully internalize the costs of negative outcomes. In this way, banks can reduce the surplus they have to offer to lower ability traders. In addition, we find that increasing banks’ capital requirements does not unambiguously lead to reduced risk-taking by their top traders.
Original languageEnglish
Place of PublicationTilburg
PublisherTILEC
Number of pages23
Volume2012-003
Publication statusPublished - 2012

Publication series

NameTILEC Discussion Paper
Volume2012-003

Fingerprint

Traders
Incentives
Adverse selection
Surplus
Politicians
Financial crisis
Capital requirements
Bank capital
Moral hazard
Risk taking
Labour market
Remuneration
Costs

Keywords

  • optimal contracts
  • remuneration policy
  • imperfect competition
  • financial institutions
  • risk

Cite this

Bijlsma, M., Boone, J., & Zwart, G. (2012). Competition for Traders and Risk. (TILEC Discussion Paper; Vol. 2012-003). Tilburg: TILEC.
Bijlsma, M. ; Boone, J. ; Zwart, Gijsbert. / Competition for Traders and Risk. Tilburg : TILEC, 2012. (TILEC Discussion Paper).
@techreport{83b48d7633394d219e449b78b3f6e6b7,
title = "Competition for Traders and Risk",
abstract = "Abstract: The financial crisis has been attributed partly to perverse incentives for traders at banks and has led policy makers to propose regulation of banks’ remuneration packages. We explain why poor incentives for traders cannot be fully resolved by only regulating the bank’s top executives, and why direct intervention in trader compensation is called for. We present a model with both trader moral hazard and adverse selection on trader abilities. We demonstrate that as competition on the labour market for traders intensifies, banks optimally offer top traders contracts inducing them to take more risk, even if banks fully internalize the costs of negative outcomes. In this way, banks can reduce the surplus they have to offer to lower ability traders. In addition, we find that increasing banks’ capital requirements does not unambiguously lead to reduced risk-taking by their top traders.",
keywords = "optimal contracts, remuneration policy, imperfect competition, financial institutions, risk",
author = "M. Bijlsma and J. Boone and Gijsbert Zwart",
note = "Pagination: 23",
year = "2012",
language = "English",
volume = "2012-003",
series = "TILEC Discussion Paper",
publisher = "TILEC",
type = "WorkingPaper",
institution = "TILEC",

}

Bijlsma, M, Boone, J & Zwart, G 2012 'Competition for Traders and Risk' TILEC Discussion Paper, vol. 2012-003, TILEC, Tilburg.

Competition for Traders and Risk. / Bijlsma, M.; Boone, J.; Zwart, Gijsbert.

Tilburg : TILEC, 2012. (TILEC Discussion Paper; Vol. 2012-003).

Research output: Working paperDiscussion paperOther research output

TY - UNPB

T1 - Competition for Traders and Risk

AU - Bijlsma, M.

AU - Boone, J.

AU - Zwart, Gijsbert

N1 - Pagination: 23

PY - 2012

Y1 - 2012

N2 - Abstract: The financial crisis has been attributed partly to perverse incentives for traders at banks and has led policy makers to propose regulation of banks’ remuneration packages. We explain why poor incentives for traders cannot be fully resolved by only regulating the bank’s top executives, and why direct intervention in trader compensation is called for. We present a model with both trader moral hazard and adverse selection on trader abilities. We demonstrate that as competition on the labour market for traders intensifies, banks optimally offer top traders contracts inducing them to take more risk, even if banks fully internalize the costs of negative outcomes. In this way, banks can reduce the surplus they have to offer to lower ability traders. In addition, we find that increasing banks’ capital requirements does not unambiguously lead to reduced risk-taking by their top traders.

AB - Abstract: The financial crisis has been attributed partly to perverse incentives for traders at banks and has led policy makers to propose regulation of banks’ remuneration packages. We explain why poor incentives for traders cannot be fully resolved by only regulating the bank’s top executives, and why direct intervention in trader compensation is called for. We present a model with both trader moral hazard and adverse selection on trader abilities. We demonstrate that as competition on the labour market for traders intensifies, banks optimally offer top traders contracts inducing them to take more risk, even if banks fully internalize the costs of negative outcomes. In this way, banks can reduce the surplus they have to offer to lower ability traders. In addition, we find that increasing banks’ capital requirements does not unambiguously lead to reduced risk-taking by their top traders.

KW - optimal contracts

KW - remuneration policy

KW - imperfect competition

KW - financial institutions

KW - risk

M3 - Discussion paper

VL - 2012-003

T3 - TILEC Discussion Paper

BT - Competition for Traders and Risk

PB - TILEC

CY - Tilburg

ER -

Bijlsma M, Boone J, Zwart G. Competition for Traders and Risk. Tilburg: TILEC. 2012. (TILEC Discussion Paper).