How to discipline financial markets: reputation is not enough

Maria Bigoni, Gabriele Camera () and Marco Casari
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Maria Bigoni: University of Bologna
Gabriele Camera: Economic Science Institute, Chapman University
Marco Casari: University of Bologna

Working Papers from Chapman University, Economic Science Institute

Abstract: Historically, shocks originating in the financial sector often spilled over into the real sector with dramatic consequences. We study in the lab how interventions targeting disclosure and capital requirements of financial intermediaries can reduce insolvencies or prevent their negative effects from propagating to the broader economy. In our two-sector economy, consumers and producers can fund financial intermediaries, who in turn provide them with liquidity to settle trades. However, intermediaries may undertake risky investments and become insolvent, which depresses real economic activity. In the experiment, insolvencies were frequent. As a consequence, consumers and producers often refused to fund intermediaries, which lowered the trade volume. Imposing the disclosure of risky investments did not reduce risk-taking and insolvencies. Instead, imposing capital requirements prevented insolvencies from disrupting real economic activity, thus boosting financial intermediation and trade.

Keywords: Asymmetric information; Laboratory experiment; Limited Liability; Prudential regulation (search for similar items in EconPapers)
JEL-codes: C92 D82 E44 (search for similar items in EconPapers)
Date: 2024
New Economics Papers: this item is included in nep-exp and nep-fdg
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Persistent link: https://EconPapers.repec.org/RePEc:chu:wpaper:24-18

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