Benefit-Cost Analysis for Financial Regulation

Abstract

Calls for benefit-cost analysis in rule-making based on the Dodd-Frank Wall Street Reform Act have revealed a paucity of work on allocative efficiency in financial markets. We propose three principles to help fill this gap. First, we highlight the need to quantify the "statistical cost of a crisis" in order to trade-off the risk of a crisis against loss of growth during good times. Second, we propose a framework quantifying the social value of price discovery and highlighting which arbitrages are over- and under-supplied from a social perspective. Finally, we distinguish between insurance benefits and gambling-facilitation harms of market completion.

Keywords: benefit-cost analysis, financial regulation, allocative efficiency, price discovery

JEL Classification: D61, G18, G28