Market-Based Regulation and the Informational Content of Prices

54 Pages Posted: 7 Dec 2012

See all articles by Philip Bond

Philip Bond

University of Washington - Michael G. Foster School of Business

Itay Goldstein

University of Pennsylvania - The Wharton School - Finance Department

Edward S. Prescott

Federal Reserve Banks - Federal Reserve Bank of Cleveland

Multiple version iconThere are 2 versions of this paper

Date Written: November 1, 2006

Abstract

Various laws and policy proposals call for regulators to make use of the information reflected in market prices. We focus on a leading example of such a proposal, namely that bank supervision should make use of the market prices of traded bank securities. We study the theoretical underpinnings of this proposal in light of a key problem: if the regulator uses market prices, prices adjust to reflect this use and potentially become less revealing. We show that the feasibility of this proposal depends critically on the information gap between the market and the regulator. Thus, there is a strong complementarity between market information and the regulator's information, which suggests that regulators should not abandon other sources of information when learning from market prices. We demonstrate that the type of security being traded matters for the observed equilibrium outcome and discuss other policy measures that can increase the ability of regulators to make use of market information.

Keywords: rational expectations, regulation, market discipline

JEL Classification: D82, D84, G14, G21

Suggested Citation

Bond, Philip and Goldstein, Itay and Prescott, Edward (Ned) Simpson, Market-Based Regulation and the Informational Content of Prices (November 1, 2006). FRB Richmond Working Paper No. 06-12. Available at SSRN: https://ssrn.com/abstract=2186154 or http://dx.doi.org/10.2139/ssrn.2186154

Philip Bond

University of Washington - Michael G. Foster School of Business ( email )

Box 353200
Seattle, WA 98195-3200
United States

Itay Goldstein

University of Pennsylvania - The Wharton School - Finance Department ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States
215-746-0499 (Phone)

Edward (Ned) Simpson Prescott (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Cleveland ( email )

P.O. Box 6387
Cleveland, OH 44101
United States

HOME PAGE: http://https://www.clevelandfed.org/people-search?pid=f8ca941e-4b51-41f6-95f8-c87f1d3806e5

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