American Economic Review
ISSN 0002-8282 (Print) | ISSN 1944-7981 (Online)
Prudential Policy with Distorted Beliefs
American Economic Review
vol. 113,
no. 7, July 2023
(pp. 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.Citation
Dávila, Eduardo, and Ansgar Walther. 2023. "Prudential Policy with Distorted Beliefs." American Economic Review, 113 (7): 1967–2006. DOI: 10.1257/aer.20210753Additional Materials
JEL Classification
- D62 Externalities
- D83 Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
- E52 Monetary Policy
- G01 Financial Crises
- G21 Banks; Depository Institutions; Micro Finance Institutions; Mortgages
- G28 Financial Institutions and Services: Government Policy and Regulation
- H81 Governmental Loans; Loan Guarantees; Credits; Grants; Bailouts