Model Secrecy and Stress Tests

58 Pages Posted: 15 Jun 2020 Last revised: 26 Jun 2023

See all articles by Yaron Leitner

Yaron Leitner

Washington University in St. Louis, Olin Business School

Basil Williams

New York University (NYU)

Multiple version iconThere are 2 versions of this paper

Date Written: April 2023

Abstract

Should regulators reveal the models they use to stress test banks? In our setting, revealing leads to gaming, but secrecy can induce banks to underinvest in socially desirable assets for fear of failing the test. We show that although the regulator can solve this underinvestment problem by making the test easier, some disclosure may still be optimal (e.g., if banks have a high appetite for risk or if capital shortfalls are not very costly). Cutoff rules are optimal within monotone disclosure rules, but more generally, optimal disclosure is single-peaked. We discuss policy implications and offer applications beyond stress tests.

Keywords: Stress Tests, Bayesian Persuasion, Information Disclosure, Delegation, Bank Incentives, Fed Models

JEL Classification: D82, G01, G28

Suggested Citation

Leitner, Yaron and Williams, Basil, Model Secrecy and Stress Tests (April 2023). Journal of Finance, Volume 78, April 2023, Pages 1055-1095, Available at SSRN: https://ssrn.com/abstract=3606654 or http://dx.doi.org/10.2139/ssrn.3606654

Yaron Leitner (Contact Author)

Washington University in St. Louis, Olin Business School

United States

Basil Williams

New York University (NYU) ( email )

19 W 4th Street
New York, NY 10003-711
United States

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