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Model Secrecy And Stress Tests

Author

Listed:
  • Yaron Leitner
  • Basil Williams

Abstract

Conventional wisdom holds that the models used to stress test banks should be kept secret to prevent gaming. We show instead that secrecy can be suboptimal, because although it deters gaming, it may also deter socially desirable investment. When the regulator can choose the minimum standard for passing the test, we show that secrecy is suboptimal if the regulator is sufficiently uncertain regarding bank characteristics. When failing the bank is socially costly, then under some conditions, secrecy is suboptimal when the bank's private cost of failure is either sufficiently high or sufficiently low.

Suggested Citation

  • Yaron Leitner & Basil Williams, 2017. "Model Secrecy And Stress Tests," Working Papers 17-41, Federal Reserve Bank of Philadelphia.
    • Handle: RePEc:fip:fedpwp:17-41
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    File URL: https://www.philadelphiafed.org/-/media/frbp/assets/working-papers/2017/wp17-41.pdf
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    Citations

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    Cited by:

    1. Goldstein, Itay & Leitner, Yaron, 2018. "Stress tests and information disclosure," Journal of Economic Theory, Elsevier, vol. 177(C), pages 34-69.
    2. Leitner, Yaron & Yilmaz, Bilge, 2019. "Regulating a model," Journal of Financial Economics, Elsevier, vol. 131(2), pages 251-268.
    3. Gu, Jiadong, 2023. "Optimal stress tests and liquidation cost," Journal of Economic Dynamics and Control, Elsevier, vol. 146(C).
    4. Carlos Corona & Lin Nan & Gaoqing Zhang, 2019. "The Coordination Role of Stress Tests in Bank Risk‐Taking," Journal of Accounting Research, Wiley Blackwell, vol. 57(5), pages 1161-1200, December.

    More about this item

    Keywords

    stress tests; information disclosure; delegation; bank incentives; Fed models;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G01 - Financial Economics - - General - - - Financial Crises

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