Prudential Policy with Distorted Beliefs

Eduardo Davila and Ansgar Walther
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Ansgar Walther: Imperial College London and CEPR

No 2336, Cowles Foundation Discussion Papers from Cowles Foundation for Research in Economics, Yale University

Abstract: This paper studies leverage regulation when equity investors and/or creditors have distorted beliefs relative to a planner. We characterize how the optimal regulation responds to arbitrary changes in investors'/creditors' beliefs, relating our results to practical scenarios. We show that the optimal regulation depends on the type and magnitude of such changes. Optimism by investors calls for looser leverage regulation, while optimism by creditors, or jointly by both investors/creditors, calls for tighter leverage regulation. Our results apply to environments with i) planners with imperfect knowledge of investors'/creditors' beliefs, ii) monetary policy, iii) bailouts and pecuniary externalities, and iv) endogenous beliefs.

Keywords: prudential policy; distorted beliefs; leverage regulation; robust optimal policy; monetary policy; bailouts; pecuniary externalities (search for similar items in EconPapers)
JEL-codes: E52 E61 G21 G28 (search for similar items in EconPapers)
Pages: 73 pages
Date: 2022-06
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Related works:
Journal Article: Prudential Policy with Distorted Beliefs (2023)
Working Paper: Prudential Policy with Distorted Beliefs (2021)
Working Paper: Prudential Policy with Distorted Beliefs (2021)
Working Paper: Prudential policy with distorted beliefs (2021)
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