Working Papers

Regulatory Model Secrecy and Bank Reporting Discretion 

The Brattle Group Ph.D. Candidate Award For Outstanding Research, WFA, 2024

This paper examines how banking regulators should disclose the models used to assess banks when banks may misreport to influence these assessments. Disclosing these models provides banks with system-wide information, but it also creates opportunities for banks with low-value assets to manipulate reports in order to obtain favorable assessments. Although regulators can mitigate manipulation by adjusting assessment rules, disclosure decisions remain crucial. The optimal policy is to disclose the models when banks' manipulation is more likely to distort assessments and keep them secret otherwise. Thus, disclosing the models complements the assessment rules by reducing manipulation when it poses greater harm to regulators.

Selected presentations: WFA, Chicago-Minnesota Theory Conference, European Winter Meeting of the Econometric Society...

Banks Incentive Pay, Diversification and Systemic Risk

with Fabio Castiglionesi, Journal of Banking and Finance, forthcoming

This paper analyzes the impact of incentive pay for bank managers on financial stability. The study focuses on two banks owned by risk-neutral principals but operated by risk-averse managers who decide on leverage and the extent of diversification into the other bank’s assets, both of which determine the systemic risk. To begin, we establish the optimal incentive pay contract assuming a planner seeks to maximize the total value of the banks. In equilibrium, we find that the contract excessively relies on relative performance evaluation, leading to an inefficiently high degree of diversification, leverage, and systemic risk. This outcome obtains even when the principal represents the interests of all stakeholders in an individual bank. We demonstrate that only regulation specifically targeting relative performance evaluation can restore efficiency, while existing regulations on managerial pay can inadvertently amplify systemic risk.

Work in Progress

Bank Regulations and Market Discipline

Basel regulations permit banks to use internal risk models to report their risks to regulators and markets. However, banks may strategically understate risks. This paper explores the optimal bank regulations, taking into account the role of market discipline. We show that, when banks' risks are observable, capital requirements alone ensure efficiency. However, in cases where banks' risks are unobservable, regulators must combine capital requirements with audits to discourage banks' misreporting. Market discipline strengthens the bank regulations. We show that regulators may rely more on audits while relaxing the capital requirements when market discipline is present. This study provides insights into the interplay between bank regulations and market discipline.

Information Regime and Portfolio Choice for Inattentive Investors

with Peicong (Keri) Hu

We examine how fund managers make use of two tools--portfolio choice and information regime choice--to attract capital from investors. In this paper, the investors are rationally inattentive and have different preferences for portfolio companies compared to the fund managers. To attract more investment, the fund managers can align portfolio choices with the investors' preference and/or provide information in a way that reduces the processing cost for the investors. Both choices impact how investors allocate their attention, which in turn influences their investment decisions. To serve as a benchmark, we show that the choice of information regime is irrelevant when the investors are attentive. This is because the fund managers can adjust the portfolio composition to ensure that the investors always provide the same level of investment. However, when the investors are inattentive, both the information regime and the portfolio composition matter for their investment decisions. We show that, when the fund managers choose the information regime alone, they may prefer providing either detailed or aggregated information to the investors, depending on the investors' information processing capacity and preference. We also explore scenarios where the fund managers choose the portfolio alone or both tools simultaneously.