The Coordination Role of Stress Tests in Bank Risk Taking
67 Pages Posted: 5 Jul 2018 Last revised: 2 Jun 2019
Date Written: November 2018
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.
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