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The Structure and Regulation of Financial Markets$
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Peter D. Spencer

Print publication date: 2000

Print ISBN-13: 9780198776093

Published to Oxford Scholarship Online: October 2011

DOI: 10.1093/acprof:oso/9780198776093.001.0001

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Convexity, Excessive Risk and Bank Regulation

Convexity, Excessive Risk and Bank Regulation

(p.176) (p.177) 9 Convexity, Excessive Risk and Bank Regulation
The Structure and Regulation of Financial Markets

Peter d. Spencer

Oxford University Press

It was shown in previous chapters that non-financial penalties could reach incentive efficiency in a debt-financed system without collateral, but that, in practice, the probability of detection and prosecution may not be a sufficient deterrent to a financial crime. In the same way, non-financial penalties may not be enough to prevent moral hazard. There are capital requirements for upholding honesty and effort in the financial markets. This chapter explores moral hazard in the bank loan and public bond markets, and the ways in which investors can protect themselves. In the previous chapters it was noted that shareholders could align company directors’ interests with their own. If these devices are effective, they can also align managers’ interests with those of shareholders and not of the debtholders. The chapter also presents moral hazard, bond covenants, and accounting systems, as well as bank loan and public debt instruments.

Keywords:   moral hazard, bank loans, bond covenant, accounting system, public debt, instruments, bank regulations

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