Social and Behavioral Sciences Commons^™

A Regulatory Arbitrage Game: Off-Balance-Sheet Leverage And Financial Fragility., Dimitris Voliotis

Dimitris Voliotis

This study examines a simple banking system in a game-theoretic frameworkwherein banks act as self-interested agents to maximize leverage at the expenseof overall financial stability. The resultant strategic inefficiency raises concernsabout how banks manage the “financial stability” good, which is appropriated intoa “tragedy of the commons”. We conceptualize the inefficiency using the -priceof anarchy- introduced by Koutsoupias and Papadimitriou [2009].We seek the optimal regulatory framework that minimizes the -price of anarchy- or the degree offinancial fragility.