Optimal Regulation of Financial Intermediaries

Sebastian Di Tella

American Economic Review, 2019, vol. 109, issue 1, 271-313

Abstract: I characterize the optimal financial regulation policy in an economy where financial intermediaries trade capital assets on behalf of households, but must retain an equity stake to align incentives. Financial regulation is necessary because intermediaries cannot be excluded from privately trading in capital markets. They don't internalize that high asset prices force everyone to bear more risk. The socially optimal allocation can be implemented with a tax on asset holdings. I derive a sufficient statistic for the externality in terms of observable variables, valid for heterogeneous intermediaries and asset classes, and arbitrary aggregate shocks. I use market data on leverage and volatility of intermediaries' equity to measure the externality, which co-moves with the business cycle.

JEL-codes: D82 G01 G12 G20 G31 H25 (search for similar items in EconPapers)
Date: 2019
Note: DOI: 10.1257/aer.20161488
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Citations: View citations in EconPapers (18)

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