Stress Tests and Information Disclosure

Abstract

We study an optimal disclosure policy of a regulator that has information about banks (e.g., from conducting stress tests).We focus on the following tradeo¤: Disclosing some information may be necessary to prevent a market breakdown, but disclosing too much information destroys risk-sharing opportunities (the Hirshleifer e¤ect).We …nd that during normal times, no disclosure is optimal, but during bad times, some disclosure is necessary.We characterize its optimal form, e.g., under what conditions a simple cuto¤ rule is optimal.We relate our results to the Bayesian persuasion literature.

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