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Model Secrecy and Stress Tests

Author

Listed:
  • Yaron Leitner

    (Federal Reserve Bank of Philadelphia)

  • Basil Williams

    (New York University)

Abstract

Conventional wisdom holds that the models used to stress test banks should be kept secret to prevent gaming. We show instead that secrecy can be suboptimal, because although it deters gaming, it may also deter socially desirable investment. When the regulator can choose the minimum standard for passing the test, we show that secrecy is suboptimal if the regulator is sufficiently uncertain regarding bank characteristics. When failing the bank is socially costly, then under some conditions, secrecy is suboptimal when the bank's private cost of failure is either sufficiently high or sufficiently low. Finally, we relate our results to several current and proposed stress testing policies.

Suggested Citation

  • Yaron Leitner & Basil Williams, 2018. "Model Secrecy and Stress Tests," 2018 Meeting Papers 566, Society for Economic Dynamics.
    • Handle: RePEc:red:sed018:566
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    References listed on IDEAS

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    Cited by:

    1. Ding, Haina & Guembel, Alexander & Ozanne, Alessio, 2020. "Market Information in Banking Supervision: The Role of Stress Test Design," TSE Working Papers 20-1144, Toulouse School of Economics (TSE).
    2. Nguyen, Thach Vu Hong & Ahmed, Shamim & Chevapatrakul, Thanaset & Onali, Enrico, 2020. "Do stress tests affect bank liquidity creation?," Journal of Corporate Finance, Elsevier, vol. 64(C).

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