Using Price Information as an Instrument of Market Discipline in Regulating Bank Risk

42 Pages Posted: 27 Mar 2008

See all articles by Duane J. Seppi

Duane J. Seppi

Carnegie Mellon University - David A. Tepper School of Business

Alfred Lehar

University of Calgary - Haskayne School of Business

Günter Strobl

University of Vienna - Department of Finance

Date Written: October 1, 2007

Abstract

An important trend in bank regulation is greater reliance on market discipline. In particular, information impounded in securities prices is increasingly used to complement supervisory activities of regulators with limited resources. The goal of this paper is to analyze the theoretical foundations of market-based bank regulation. We find that price information only improves the efficiency of the regulator's monitoring function if the banks' risk-shifting incentives are not too large. Further, if the regulator cannot commit to an ex ante suboptimal auditing policy, market-based bank regulation can lead to more risk taking in equilibrium, increasing the expected payments by the deposit insurance agency. Finally, we show that the regulatory use of market information can decrease the investors' incentives to acquire costly information, thereby reducing the informativeness of stock prices.

JEL Classification: G21, G28

Suggested Citation

Seppi, Duane J. and Lehar, Alfred and Strobl, Günter, Using Price Information as an Instrument of Market Discipline in Regulating Bank Risk (October 1, 2007). Available at SSRN: https://ssrn.com/abstract=1108627 or http://dx.doi.org/10.2139/ssrn.1108627

Duane J. Seppi

Carnegie Mellon University - David A. Tepper School of Business ( email )

5000 Forbes Avenue
Pittsburgh, PA 15213-3890
United States
412-268-2298 (Phone)
412-268-8896 (Fax)

Alfred Lehar (Contact Author)

University of Calgary - Haskayne School of Business ( email )

2500 University Drive, NW
Calgary, Alberta T2N 1N4
Canada
403-220-4567 (Phone)

HOME PAGE: http://homepages.ucalgary.ca/~alehar/

Günter Strobl

University of Vienna - Department of Finance ( email )

Oskar-Morgenstern-Platz 1
Vienna, 1090
Austria

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