Ernst Fehr is Professor of Economics at the University of Zurich; Michel Marechal is Associate Professor of Economics at the University of Zurich; and Alain Cohn is Assistant Professor of Information at the University of Michigan. This post is based on their recent paper.
Excessive risk-taking in the financial industry is thought to be one of the key contributor to the recent financial crisis (e.g., Diamond and Rajan, 2009; Financial Crisis Inquiry Commission, 2011; Freixas and Dewatripont, 2012). Academics and policy makers have proposed several reasons for undesirably high levels of risk taking, including flawed compensation practices (Krugman 2009), poor corporate governance (Freixas and Dewatripont, 2012), and low capital requirements (Admati and Hellwig, 2013). One explanation that has received increased attention in recent years is the financial sector’s risk culture, i.e., the norms and informal rules of behavior that may favor inappropriately high levels of risk taking. Consequently, policy makers and regulators have called for a change in the risk culture (e.g., House of Commons Treasury Committee, 2008; Power, Ashby, and Palermo, 2013; International Monetary Fund, 2014). However, there is little or no empirical evidence showing that the unwritten rules of behavior in the financial industry encourage financial professionals to take greater financial risks.
