. e. incentives, let me recall, by a way of contrast, a recent study by fahlenbrach and stulz ( 2011 ). these authors show that the losses of the banks whose managers ’ incentives were most closely aligned with the long - term interests of the firm they managed were at least as large, in the last crisis, as those at the financial institutions where governance was more obviously lacking. this suggests that wrong incentives were not the only factor in the behaviour and decisions that led to the crisis. knowledge and competence were also at play.... or a misalignment of incentives? incentives are an important component in risk and risk - taking. if there is an important lesson in economics and finance that has not been invalidated by the financial crisis, it is that incentives really do matter. the excessive risk - taking that was observed prior to the financial crisis is likely to have been – among other things – the result of the fact that key decisionmakers were not provided with the right incentives to carefully analyse and balance the possible consequences of the risks they agreed to take. let us take a bank as an example. the main relevant stakeholders are the depositors, the shareholders, the managers and the bondholders. what follows is a review of the situation of these stakeholders in relation to the desired risk profile of a typical bank. 3 depositors deposit insurance ensures that it is not the business of depositors to worry about the amount of risk that the bank, in which he or she has deposited his money, decides to take. a key lesson of the great depression was that deposit insurance is a socially justified feature of the banking system. this follows from the fact that banks are institutions vulnerable to bank runs, no matter how well they are managed. the principle of deposit insurance is widely accepted and i will not further question it. yet, the extent of deposit insurance and the form of its financing are important questions. recent history has refocused our attention on these matters, but these are not the issues i would like to deal with today. shareholders the incentives for shareholders differ from those of depositors. at first sight shareholders, as ultimate owners of the bank, can be counted on to discipline risktaking by the institution they own. after all, they stand to lose their entire stake if the risks taken lead to bankruptcy. however, this is only true to a limited extent. indeed, if we go beyond an initial, superficial consideration of the situation, we soon realise that

is intimately linked with the concept of luck. in a risky world, heroes are more likely to be lucky than smart. in asset management, for instance, barras, scaillet and wermers ( 2010 ) find that around 8 % of mutual funds display a significant positive alpha, but of them only about 0. 5 % deliver a positive alpha that is not driven by luck. one question that arises from this finding is whether the associated statistics would be very different for the group of successful bank managers or successful traders in financial markets. yet remuneration schemes do not appear to take this identification problem into account. it can be hypothesised that bonus payments are often a reward for luck rather than compensation for actual skill or effort. this hypothesis represents a very significant challenge for an efficient financial system. it is a challenge for a new school of finance. we need to improve our ability to distinguish between skill and luck. simultaneously we need to draw the adequate conclusions from the difficulties that will always exist in signal extraction on this issue. excessive risk - taking : lack of knowledge... let me now turn to the question of financial risk - taking. overall, there is no ( expected ) return and no growth without risk so we have to be careful to foster a sufficiently pro - risk society. but risk calculus – weighing the marginal advantages and disadvantages of taking more risk – is a difficult exercise. it is difficult because it entails probabilities, that are hard to assess, over future scenarios which are themselves often hard to describe fully and accurately. and the difficulty increases by an additional step if there is an externality, that is, if the private and social cost and benefit of additional risk - taking differ. one can plausibly wilmott, p. ( 2009 ) “ financial modelers ’ manifesto ”, available at www. willmott. com, january 2009. bis central bankers ’ speeches argue that the recent financial crisis was, to some extent, the result of excessive risk - taking. for the proponents of this hypothesis, the ultimate cause is in question. one possibility is that this excessive risk - taking was the result of wrong incentives, with decision - makers wilfully taking more risk for themselves or their institutions than would have been privately or socially desirable. the alternative would be that a misperception of the probabilities and possible consequences of the decisions was the prime cause : a lack of knowledge or competence. since i will essentially concentrate on the first possibility, i