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Excessive bank risk-taking in an infinite horizon economy
(Elsevier B.V., 2024-08-01)
We develop a dynamic framework to study banks’ incentives to take excessive risk in an emerging economy, where bank default probability and excess bank risk-taking are modeled endogenously. We calibrate it for the 1998 Peruvian economy. We find that the infinite-period feature amplifies banks’ incentives to take excessive risk. When we simulate the sudden stop that hit Peru in 1998, the model accurately predicts the substantial short-term rise in the non-performing loans ratio through the rise of the bank default probability.

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