Abstract
We present a model in which financial firms are engaged in preemptive competition for trading opportunities and the cost of risk management increases with time pressure. Because time pressure is in turn endogenous to risk management choices, strategic complementarities can trigger a race to the bottom: firms’ decisions to abandon risk management, while individually rational, are collectively inefficient. Market immediacy and trading volume are inversely related to the efficiency of risk allocation. Externalities operate through opportunity costs and agency costs, and support regulations that view risk management as both a governance problem (inside firms) and a coordination problem (among firms).
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