Prudential Policy with Distorted Beliefs

Eduardo Davila and Ansgar Walther

American Economic Review, 2023, vol. 113, issue 7, 1967-2006

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.

JEL-codes: D62 D83 E52 G01 G21 G28 H81 (search for similar items in EconPapers)
Date: 2023
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Citations: View citations in EconPapers (3)

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Related works:
Working Paper: Prudential Policy with Distorted Beliefs (2022)
Working Paper: Prudential Policy with Distorted Beliefs (2021)
Working Paper: Prudential Policy with Distorted Beliefs (2021)
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DOI: 10.1257/aer.20210753

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