Model Secrecy and Stress Tests
Yaron Leitner and
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Yaron Leitner: Federal Reserve Bank of Philadelphia
Basil Williams: New York University
No 566, 2018 Meeting Papers from Society for Economic Dynamics
Conventional wisdom holds that the models used to stress test banks should be kept secret to prevent gaming. We show instead that secrecy can be suboptimal, because although it deters gaming, it may also deter socially desirable investment. When the regulator can choose the minimum standard for passing the test, we show that secrecy is suboptimal if the regulator is sufficiently uncertain regarding bank characteristics. When failing the bank is socially costly, then under some conditions, secrecy is suboptimal when the bank's private cost of failure is either sufficiently high or sufficiently low. Finally, we relate our results to several current and proposed stress testing policies.
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