Stress tests and model monoculture

Keeyoung Rhee and Keshav Dogra

Journal of Financial Economics, 2024, vol. 152, issue C

Abstract: We study whether regulators should reveal stress test results that contain imperfect information about banks' financial health. Although disclosure restores market confidence in banks, it misclassifies some healthy banks as risky. This encourages banks to choose portfolios deemed safe by regulators, leading to model monoculture and making the financial system less diversified. Under the ex-ante optimal disclosure policy, the regulator addresses this tradeoff by fully revealing stress test results when adverse selection is very severe or very mild, but never disclosing the results otherwise.

Keywords: Stress tests; Adverse selection; Model monoculture; Information design (search for similar items in EconPapers)
JEL-codes: D82 G11 G18 (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:152:y:2024:i:c:s0304405x23002003

DOI: 10.1016/j.jfineco.2023.103760

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