Protecting Savings: Do We Need a Supervision Authority?
We apply a three-tier hierarchical model of regulation, developed along the lines of Laffont and Tiroleâ€™s (1993), to an adverse selection problem in the corporate bond market. The bank brings the bonds to the market and informs the potential buyers about the bondsâ€™ risk; a unique benevolent public authority aims at maximising saversâ€™ welfare. The main goal is to investigate whether this unique authority is able to fully inform the market on firmsâ€™ true credit worthiness when banks, in order to recover doubtful credits, favour the placement of bonds issued by levered firms by concealing their true risk. We establish the necessary condition that allows the optimal sanctions to produce the first best equilibrium.
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