Risk reduction as a signal of quality in banks with nonverifiable losses

This paper explores whether the observed differences in bank risk taking behavior can signal asset quality when crisis-induced losses cannot be credibly disclosed. Specifically, it examines whether reduced risk taking under asymmetric information can indicate higher asset quality. I show that even when all banks have gambling incentives regardless of their asset quality, these incentives may be tempered for banks with assets of higher quality by their motivation to signal their type.