Persuasion by Stress Testing: Optimal Disclosure of Supervisory Information in the Banking Sector

Wolfgang Gick

Harvard University – Center for European Studies; Tufts University – Economics Department

Thilo Pausch

Deutsche Bundesbank

2012

Bundesbank Discussion Paper No. 32/2012

Abstract:

The game-theoretical analysis of this paper shows that stress tests that cover the entire banking sector (macro stress tests) can be performed by institutional supervisors to improve welfare. In a multi-receiver framework of Bayesian persuasion we show that a banking authority can create value when committing to disclose the stress-testing methodology (signal-generating process) together with the stress test result (signal). Disclosing two pieces of information is a typical procedure used in stress tests. By optimally choosing these two signals, supervisors can deliver superior information to prudent investors and enhance welfare. The paper offers a new theory to explain why stress tests are generally welfare enhancing. We also offer a treatment of the borderline case where the banking sector is hit by a crisis, in which case the supervisor will optimally disclose an uninformative signal.

Persuasion by Stress Testing- Optimal Disclosure of Supervisory Information in the Banking Sector

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