We study a situation in which a regulator relies on risk models that banks produce in order to regulate them. A bank can generate more than one model and choose which models to reveal to the regulator. The regulator can find out the other models by monitoring the bank, but in equilibrium, monitoring induces the bank to produce less information. We show that a high level of monitoring is desirable when the bank’s private gain from producing more information is either sufficiently high or sufficiently low. When public models are more precise, banks produce more information, but the regulator may end up monitoring more

Does the provision of leverage to retail traders improve market quality or facilitate socially inefficient speculation that enriches financial intermediaries? We evaluate the effects of 2010 regulations that cap leverage in the U.S. retail foreign exchange market. Using three unique data sets and a difference-in-differences approach, we document that the leverage-constraint reduces trading volume by 23%, alleviates high-leverage traders’ losses by 40%, and reduces brokerages’ operating capital by 25%. Yet, the policy does not affect the relative bid-ask prices charged by the brokerages. These results suggest the policy improves belief-neutral social welfare without reducing market liquidity

We consider a dynamic model in which receiving support from the lender of last resort (LLR) may help banks to weather investor runs. We show the need for regulatory liquidity standards when the underlying social trade-offs make the uninformed LLR inclined to support troubled banks during a run. Liquidity standards increase the time available before the LLR must decide on supporting the bank. This facilitates the arrival of information on the bank’s financial condition and improves the efficiency of the decision taken by the LLR, a role that can be modified but not replaced with the use of capital regulation

Exploiting Nasdaq order book data and difference-in-differences methodology, we identify the distinct effects of trading pause mechanisms introduced on US stock exchanges after May 2010. We show that the mere existence of such a regulation makes market participants behave differently in anticipation of a pause. Pauses enhance price discovery during the break but have adverse effects on price stability and liquidity after the pause. We find that pauses ultimately do not “cool off” markets but cause extra volatility. This implies a regulatory trade-off between the protective role of trading pauses and their adverse effects on market quality

We study real-efficiency implications of disclosing public information in a model with multiple dimensions of uncertainty where market prices convey information to a real decision maker. Paradoxically, when disclosure concerns a variable that the real decision maker cares to learn about, disclosure negatively affects price informativeness, and in markets that are effective in aggregating private information, this negative price-informativeness effect can dominate so that better disclosure negatively impacts real efficiency. When disclosure concerns a variable that the real decision maker already knows much about, disclosure always improves price informativeness and real efficiency. Our analysis has important empirical and policy implications for different contexts such as disclosure of stress test information and regulation of credit ratings