Abstract
We show that limited liability can induce profit-maximizing bank owners to herd with other banks. When bank loan returns have a systematic factor, the failure of one bank conveys adverse information about this systematic factor and increases the cost of borrowing for the surviving banks relative to the situation of no bank failures. Such information spillover is costly to profit-maximizing bank owners. Bank owners herd ex ante and undertake correlated investments to increase the likelihood of joint survival: given limited liability, bank owners are not concerned about the associated increase in the likelihood of joint failure. Competitive effects such as superior margins from lending to different industries and migration of depositors of a failed bank to the surviving bank mitigate herding incentives.
Sign-in/Register to access full text options 
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a callDisclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.
