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Market Information in Banking Supervision: The Role of Stress Test Design

Ding, Haina and Guembel, Alexander (2020) Market Information in Banking Supervision: The Role of Stress Test Design. TSE Working Paper, n. 20-1144, Toulouse

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Abstract

This paper studies the optimal degree of leniency in a bank stress test, when poorly capitalized banks engage in risk shifting and a banking supervisor can intervene to prevent it. The stress test directly provides the supervisor with noisy information about whether or not a bank is well capitalized. Furthermore, the stress test outcome aspects a speculator's incentives to acquire costly information about the bank and trade in its shares. This in turn aspects the amount of market information available to the supervisor when she takes her intervention decision. We show that a supervisor optimally distorts the stress test towards leniency for banks whose shares are relatively illiquid, and about whom the supervisor has little private information. When the supervisor has substantial private information about a bank whose shares are fairly liquid, it is optimal to apply a conservative stress test.

Item Type: Monograph (Working Paper)
Language: English
Date: September 2020
Place of Publication: Toulouse
Uncontrolled Keywords: Stress test, leniency, monitoring, feedback, risk shifting
JEL Classification: G14 - Information and Market Efficiency; Event Studies
G28 - Government Policy and Regulation
Subjects: B- ECONOMIE ET FINANCE
Divisions: TSE-R (Toulouse)
Institution: Université Toulouse 1 Capitole
Site: UT1
Date Deposited: 15 Sep 2020 08:23
Last Modified: 15 Sep 2020 08:23
["eprint_fieldname_oai_identifier" not defined]: oai:tse-fr.eu:124671
URI: http://publications.ut-capitole.fr/id/eprint/41785

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