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  3. American Economic Review
  4. January 2019
  5. Optimal Regulation of Financial Intermediaries

American Economic Review

ISSN 0002-8282 (Print) | ISSN 1944-7981 (Online)

Optimal Regulation of Financial Intermediaries

  • Sebastian Di Tella
American Economic Review
vol. 109, no. 1, January 2019
(pp. 271–313)
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Abstract

I characterize the optimal financial regulation policy in an economy where financial intermediaries trade capital assets on behalf of households, but must retain an equity stake to align incentives. Financial regulation is necessary because intermediaries cannot be excluded from privately trading in capital markets. They don't internalize that high asset prices force everyone to bear more risk. The socially optimal allocation can be implemented with a tax on asset holdings. I derive a sufficient statistic for the externality in terms of observable variables, valid for heterogeneous intermediaries and asset classes, and arbitrary aggregate shocks. I use market data on leverage and volatility of intermediaries' equity to measure the externality, which co-moves with the business cycle.

Citation

Di Tella, Sebastian. 2019. "Optimal Regulation of Financial Intermediaries." American Economic Review, 109 (1): 271–313. DOI: 10.1257/aer.20161488

Additional Materials

JEL Classification

  • D82 Asymmetric and Private Information; Mechanism Design
  • G01 Financial Crises
  • G12 Asset Pricing; Trading Volume; Bond Interest Rates
  • G20 Financial Institutions and Services: General
  • G31 Capital Budgeting; Fixed Investment and Inventory Studies; Capacity
  • H25 Business Taxes and Subsidies including sales and value-added (VAT)