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Regulating Financial Networks Under Uncertainty

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Abstract

I study the problem of regulating a network of interdependent financial institutions that is prone to contagion when there is uncertainty regarding its precise structure. I show that such uncertainty reduces the scope for welfare-improving interventions. While improving network transparency potentially reduces this uncertainty, it does not always lead to welfare improvements. Under certain conditions, regulation that reduces the risk-taking incentives of a small set of institutions can improve welfare. The size and composition of such a set crucially depend on the interplay between (i) the (expected) susceptibility of the network to contagion, (ii) the cost of improving network transparency, (iii) the cost of regulating institutions, and (iv) investors' preferences.

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  • Carlos Ramírez, 2019. "Regulating Financial Networks Under Uncertainty," Finance and Economics Discussion Series 2019-056, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgfe:2019-56
    DOI: 10.17016/FEDS.2019.056
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    Cited by:

    1. Alvarez, Fernando & Barlevy, Gadi, 2021. "Mandatory disclosure and financial contagion," Journal of Economic Theory, Elsevier, vol. 194(C).

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    More about this item

    Keywords

    Financial networks; Contagion; Policy design under uncertainty;
    All these keywords.

    JEL classification:

    • C6 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • G01 - Financial Economics - - General - - - Financial Crises

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