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Stress tests and model monoculture

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  • Rhee, Keeyoung
  • Dogra, Keshav

Abstract

We study whether regulators should reveal stress test results that contain imperfect information about banks' financial health. Although disclosure restores market confidence in banks, it misclassifies some healthy banks as risky. This encourages banks to choose portfolios deemed safe by regulators, leading to model monoculture and making the financial system less diversified. Under the ex-ante optimal disclosure policy, the regulator addresses this tradeoff by fully revealing stress test results when adverse selection is very severe or very mild, but never disclosing the results otherwise.

Suggested Citation

  • Rhee, Keeyoung & Dogra, Keshav, 2024. "Stress tests and model monoculture," Journal of Financial Economics, Elsevier, vol. 152(C).
    • Handle: RePEc:eee:jfinec:v:152:y:2024:i:c:s0304405x23002003
    DOI: 10.1016/j.jfineco.2023.103760
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    References listed on IDEAS

    as
    1. Yaron Leitner, 2014. "Should regulators reveal information about banks?," Business Review, Federal Reserve Bank of Philadelphia, issue Q3, pages 1-8.
    2. Miguel Faria-e-Castro & Joseba Martinez & Thomas Philippon, 2017. "Runs versus Lemons: Information Disclosure and Fiscal Capacity," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 84(4), pages 1683-1707.
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    More about this item

    Keywords

    Stress tests; Adverse selection; Model monoculture; Information design;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation

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