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Financial Stability and Financial Regulation under Diagnostic Expectations in Influence

Author

Listed:
  • Antoine Camous
  • Alejandro Van der Ghote

Abstract

This paper studies the implications of “diagnostic” expectations—an empirically relevant form of non-rational extrapolation in expectation formation (Bordalo, Gennaioli and Shleifer (2018))—for financial stability and the appropriate conduct of financial regulation. We find that interactions between diagnostic expectations and financial frictions intensify instability in financial markets relative to the rational expectationsbenchmark. We also find that diagnostic expectations command tighter financial regulation, regardless of the degree of diagnostic expectations of the regulator.

Suggested Citation

  • Antoine Camous & Alejandro Van der Ghote, 2023. "Financial Stability and Financial Regulation under Diagnostic Expectations in Influence," CRC TR 224 Discussion Paper Series crctr224_2023_431, University of Bonn and University of Mannheim, Germany.
    • Handle: RePEc:bon:boncrc:crctr224_2023_431
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    File URL: https://www.crctr224.de/research/discussion-papers/archive/dp431
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    More about this item

    Keywords

    financial frictions; financial amplifications; diagnostic expectations; financial regulation;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General
    • E70 - Macroeconomics and Monetary Economics - - Macro-Based Behavioral Economics - - - General
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • G40 - Financial Economics - - Behavioral Finance - - - General

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