Dynamic volatility regulation of financial institutions

Jens Hilscher, Alon Raviv, Zvi Wiener

Research output: Contribution to journalArticlepeer-review


Unlike non-financial firms, financial institutions are often heavily regulated to prevent bankruptcies and negative spillovers. A main regulatory tool is risk-based capital requirements. To reflect this reality, we develop a model that allows for dynamically updated asset risk, in contrast to standard contingent claim models that assume constant volatility. Regulators impose a decrease in asset volatility when the capital cushion becomes small, thereby reducing the risk of distress. We show that such regulation of financial institutions affects their credit spreads, credit ratings, transition matrices, valuation of liabilities, cost of deposit insurance, and risk-shifting incentives.

Original languageEnglish
Article number104968
JournalFinance Research Letters
StatePublished - Mar 2024

Bibliographical note

Publisher Copyright:
© 2023


This paper was presented at the 2023 special-theme conference on The Effectiveness of Financial Regulation hosted by the School of Economics at the College of Management Academic Studies, Israel. Zvi Wiener thanks the Krueger Fund , and the Sanger Family Chair in Banking and Risk Management for support of this research. Alon Raviv thanks the Ackerman Family Center for Israeli Corporate Governance for support of this research.

FundersFunder number
Krueger Fund


    • Asset risk
    • Banks
    • Basel II
    • Credit spread
    • Deposit insurance
    • Dynamic volatility
    • Financial crisis
    • Leverage
    • Regulator
    • Stress test


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