Optimal Regulation and Investment Incentives in Financial Networks
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arXiv
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| Format: | Preprint |
| Published: |
2025
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| _version_ | 1866915533315637248 |
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| author | Jackson, Matthew O. Pernoud, Agathe |
| author_facet | Jackson, Matthew O. Pernoud, Agathe |
| contents | We examine optimal regulation of financial networks with debt interdependencies between financial firms. We first show that firms often have an incentive to choose excessively risky portfolios and overly correlate their portfolios with those of their counterparties. We then characterize how optimal regulation depends on a firm's financial centrality and its available investment opportunities. In standard core-periphery networks, optimal regulation depends non-monotonically on the correlation of banks' investments, with maximal restrictions for intermediate levels of correlation. Moreover, it can be uniquely optimal to treat banks asymmetrically: restricting the investments of one core bank while allowing an otherwise identical core bank (in all aspects, including network centrality) to invest freely. |
| format | Preprint |
| id |
arxiv_https___arxiv_org_abs_2506_16648 |
| institution | arXiv |
| publishDate | 2025 |
| record_format | arxiv |
| spellingShingle | Optimal Regulation and Investment Incentives in Financial Networks Jackson, Matthew O. Pernoud, Agathe General Economics Economics We examine optimal regulation of financial networks with debt interdependencies between financial firms. We first show that firms often have an incentive to choose excessively risky portfolios and overly correlate their portfolios with those of their counterparties. We then characterize how optimal regulation depends on a firm's financial centrality and its available investment opportunities. In standard core-periphery networks, optimal regulation depends non-monotonically on the correlation of banks' investments, with maximal restrictions for intermediate levels of correlation. Moreover, it can be uniquely optimal to treat banks asymmetrically: restricting the investments of one core bank while allowing an otherwise identical core bank (in all aspects, including network centrality) to invest freely. |
| title | Optimal Regulation and Investment Incentives in Financial Networks |
| topic | General Economics Economics |
| url | https://arxiv.org/abs/2506.16648 |