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Optimal Regulation of Financial Intermediaries

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  • Sebastian Di Tella

Abstract

I characterize the optimal financial regulation policy in an economy where financial intermediaries trade capital assets on behalf of households, but must retain an equity stake to align incentives. Financial regulation is necessary because intermediaries cannot be excluded from privately trading in capital markets. They don’t internalize that high asset prices force everyone to bear more risk. The socially optimal allocation can be implemented with a tax on asset holdings. I derive a sufficient statistic for the externality/optimal policy in terms of observable variables, valid for heterogenous intermediaries and asset classes, and arbitrary aggregate shocks. I use market data on leverage and volatility of intermediaries’ equity to measure the externality, which co-moves with the business cycle.

Suggested Citation

  • Sebastian Di Tella, 2017. "Optimal Regulation of Financial Intermediaries," NBER Working Papers 23586, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:23586
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    Cited by:

    1. Duffie, Darrell & Antill, Samuel, 2017. "Augmenting Markets with Mechanisms," Research Papers repec:ecl:stabus:3623, Stanford University, Graduate School of Business.

    More about this item

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G01 - Financial Economics - - General - - - Financial Crises

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