A REEXAMINATION OF MEAN-VARIANCE ANALYSIS OF BANK CAPITAL REGULATION

The mean-variance framework has been used to analyze the effects of bank capital regulation on the asset and bankruptcy risk of insured, utility-maximizing banks. This literature claims that more stringent capital regulation will increase asset risk and can increase bankruptcy risk. These conclusions are notable because they are opposite to those obtained for insured, value-maximizing banks. In this paper, we show that the utility-maximization literature does not support its conclusions regarding the effects of bank capital regulation because it has mischaracterized the bank's investment opportunity set by neglecting the option value of deposit insurance. © 1990.