NY Fed: capital structure best left to the market
A new model examining the optimal capital structure for banks shows that some degree of leverage may ensure appropriate bank behaviour, research published Wednesday by the New York Federal Reserve finds.
Under certain circumstances, tension between rent-seeking management, shareholders and bondholders is resolved by the market discipline of leverage - reducing the probability of asset-substitution moral hazard and other "risk-shifting" behaviour.
"This leads to a theory in which an optimal bank
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