Regulating a Model

51 Pages Posted: 28 Nov 2016 Last revised: 29 Apr 2020

See all articles by Yaron Leitner

Yaron Leitner

Washington University in St. Louis, Olin Business School

Bilge Yilmaz

University of Pennsylvania - Finance Department

Multiple version iconThere are 2 versions of this paper

Date Written: 2016-10-26

Abstract

REVISED: 5/2018: We study a situation in which a regulator relies on models produced by banks in order to regulate them. A bank can generate more than one model and choose which models to reveal to the regulator. The regulator can find out the other models by monitoring the bank, but, in equilibrium, monitoring induces the bank to produce less information. We show that a high level of monitoring is desirable when the bank's private gain from producing more information is either sufficiently high or sufficiently low (e.g., when the bank has a very little or very large amount of debt). When public models are more precise, banks produce more information, but the regulator may end up monitoring more

Keywords: bank regulation, Bayesian persuasion, internal-risk models, model-based regulation

JEL Classification: D82, D83, G21, G28

Suggested Citation

Leitner, Yaron and Yilmaz, Bilge, Regulating a Model (2016-10-26). FRB of Philadelphia Working Paper No. 16-31, FRB of Philadelphia Working Paper No. 16-31, Available at SSRN: https://ssrn.com/abstract=2876001

Yaron Leitner (Contact Author)

Washington University in St. Louis, Olin Business School

United States

Bilge Yilmaz

University of Pennsylvania - Finance Department ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States
215-898-1163 (Phone)
215-898-6200 (Fax)

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