Regulating Financial Networks Under Uncertainty

66 Pages Posted: 31 Jul 2020

See all articles by Carlos A. Ramírez

Carlos A. Ramírez

Board of Governors of the Federal Reserve System

Multiple version iconThere are 4 versions of this paper

Date Written: January 2020

Abstract

I study the problem of regulating a network of interdependent financial institutions that is prone to contagion when there is uncertainty regarding its precise structure. I show that such uncertainty reduces the scope for welfare-improving interventions. While improving network transparency potentially reduces this uncertainty, it does not always lead to welfare improvements. Under certain conditions, regulation that reduces the risk-taking incentives of a small set of institutions can improve welfare. The size and composition of such a set crucially depend on the interplay between (i) the (expected) susceptibility of the network to contagion, (ii) the cost of improving network transparency, (iii) the cost of regulating institutions, and (iv) investors’ preferences.

Keywords: Financial networks, contagion, policy design under uncertainty

JEL Classification: C6, E61, G01

Suggested Citation

Ramírez, Carlos, Regulating Financial Networks Under Uncertainty (January 2020). ESRB Working Paper Series No. 2020/107, Available at SSRN: https://ssrn.com/abstract=3664877

Carlos Ramírez (Contact Author)

Board of Governors of the Federal Reserve System ( email )

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