Working Paper

Stress Tests and Information Disclosure

Abstract: We study an optimal disclosure policy of a regulator that has information about banks (e.g., from conducting stress tests). In our model, disclosure can destroy risk-sharing opportunities for banks (the Hirshleifer effect). Yet, in some cases, some level of disclosure is necessary for risk sharing to occur. We provide conditions under which optimal disclosure takes a simple form (e.g., full disclosure, no disclosure, or a cutoff rule). We also show that, in some cases, optimal disclosure takes a more complicated form (e.g., multiple cutoffs or nonmonotone rules), which we characterize. We relate our results to the Bayesian persuasion literature.

Keywords: stress tests; bank regulation; Bayesian persuasion; adverse selection; optimal disclosure;

Bibliographic Information

Provider: Federal Reserve Bank of Philadelphia

Part of Series: Working Papers

Publication Date: 2017-08-22

Number: 17-28

Note: Supersedes WP13-26 & WP15-10/R