Paper Title
HEDGING THE REGULATORY RISK OF COUNTERCYCLICAL CAPITAL

Abstract
Abstract - Countercyclical capital buffer (CCB) schemes of Basel III require banks to build up equity capital during periods of high credit growth against potential losses in subsequent economic downturns.We develop CCB options for banks to hedge against this regulatory risk in the forms of raising large equity capital and/or reducing bank lending. We demonstratethat when CCB regimes are triggered in credit expansionary periods, the options provide additional capital to meet the required buffer add-on two to five years prior to a financial crisis. They are also useful as a countervailing force towards excessiverisk-takingbehaviors in the financial sector. JEL Classification: E44, G21, and G28. Keywords - Basel III capital requirements; Countercyclical capital buffer; credit-to-GDP ratio; regulatory risk; macro-prudential policy.