Regulating a Model

50 Pages Posted: 12 Apr 2018 Last revised: 7 May 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: 2019

Abstract

We study a situation in which a regulator relies on risk models that banks produce 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. When public models are more precise, banks produce more information, but the regulator may end up monitoring more.

Keywords: Bank Regulation, Bayesian Persuasion, Information Design, Internal-Risk Models, Model-Based Regulation, Stress Tests

JEL Classification: D82, D83, G21, G28

Suggested Citation

Leitner, Yaron and Yilmaz, Bilge, Regulating a Model (2019). Journal of Financial Economics, Volume 131, Issue 2, February 2019, Pages 251-268, Available at SSRN: https://ssrn.com/abstract=3157317

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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