The Coordination Role of Stress Test Disclosure in Bank Risk Taking
53 Pages Posted: 5 Jul 2018
Date Written: July 2017
We examine whether stress-test disclosures distort banks' risk-taking decisions. We study a model in which a regulator may choose to rescue banks in the event of concurrent bank failures. Our analysis reveals a novel coordination role of stress-test disclosures. By disclosing stress tests, a regulator informs all banks of the failure likelihood of other banks, which facilitates bank's coordination in risk-taking. We find that disclosing stress tests always increases the rate of bank failure and, unless bank failure externalities are sufficiently severe, disclosure also increases banks' average risk and the bailout likelihood.
Suggested Citation: Suggested Citation