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Regulating a model

Author

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  • Leitner, Yaron
  • Yilmaz, Bilge

Abstract

We study a situation in which a regulator relies on risk models that banks produce in order to regulate them. A bank can generate more than one model and choose which models to reveal to the regulator. The regulator can find out the other models by monitoring the bank, but in equilibrium, monitoring induces the bank to produce less information. We show that a high level of monitoring is desirable when the bank’s private gain from producing more information is either sufficiently high or sufficiently low. When public models are more precise, banks produce more information, but the regulator may end up monitoring more.

Suggested Citation

  • Leitner, Yaron & Yilmaz, Bilge, 2019. "Regulating a model," Journal of Financial Economics, Elsevier, vol. 131(2), pages 251-268.
    • Handle: RePEc:eee:jfinec:v:131:y:2019:i:2:p:251-268
    DOI: 10.1016/j.jfineco.2018.08.010
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    References listed on IDEAS

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    2. Biswas, Sonny & Koufopoulos, Kostas, 2022. "Bank capital structure and regulation: Overcoming and embracing adverse selection," Journal of Financial Economics, Elsevier, vol. 143(3), pages 973-992.
    3. Pereira, Ana Elisa, 2021. "Rollover risk and stress test credibility," Games and Economic Behavior, Elsevier, vol. 129(C), pages 370-399.

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    More about this item

    Keywords

    Bank regulation; Bayesian persuasion; Information design; Internal-risk models; Model-based regulation; Stress tests;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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