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 e¤ect). 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 cuto¤ rule). We also show that, in some cases, optimal disclosure takes a more complicated form (e.g., multiple cuto¤s or nonmonotone rules), which we characterize. We relate our results to the Bayesian persuasion literature.

Stress Tests and Small Business Lending

“…Goldstein and Leitner (2017) analyze theoretically the tradeoffs faced by regulators regarding disclosure of stress-test results. Several papers have studied market reactions to U.S. or European stress test announcements, with mixed evidence on whether banking firms experience significant abnormal average stock returns when supervisory stress-test results are disclosed(Peristiani et al, 2010;Petrella and Resti, 2013;Candelon and Sy, 2015;Bird et al, 2015;and Fernandes, Igan and Pinheiro, 2015) Flannery et al (2016).…”

Bank Risk Dynamics Where Assets are Risky Debt Claims

“…Second, after the financial crisis, regulators around the world started conducting periodic stress tests for financial institutions. These are forward‐looking assessments designed to determine if a bank would have adequate capital to withstand negative shocks in the future (Bayazitova and Shivdasani, ; Gofman, ; Goldstein and Sapra, ; Goldstein and Leitner, ; Greenlaw et al ., ; and Peristiani et al ., ). Our model contributes to this approach as we estimate a bank's resilience under the assumption that the bank's assets are risky debt claims.…”