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Optimal Financial Regulation and the Concentration of Aggregate Risk
October 16, 2014Macro, Trade, and Finance Seminar Series

Sebastian di Tella, Assistant Professor of Economics at the Standard Graduate School of Business, will share the results of some of his most recent research.

Excessive concentration of aggregate risk can lead to financial fragility and may create the need for financial regulation. This paper studies the optimal financial regulation policy in a standard model where financial frictions are derived from a moral hazard problem, with a focus on the allocation of aggregate risk. First, I study the competitive equilibrium where agents can write complete long-term contracts, and I derive a simple formula for the allocation of aggregate risk. I then consider the optimal allocation that can be achieved by a social planner who faces the same informational asymmetries as the market, and show the competitive equilibrium is not constrained efficient. I identify a “moral hazard externality” that appears in a wide class of models, and show how it can create incentives for an inefficient allocation of aggregate risk. Finally, I show that although the competitive equilibrium may feature excessive concentration of aggregate risk, the optimal allocation can be implemented with a tax on capital. 

Paper: Optimal Financial Regulation and the Concentration of Aggregate Risk

Last Updated: Oct 15, 2014

The Macro, Trade, and Finance Seminar Series is a weekly series hosted by the World Bank's research department. The series invites leading researchers from the fields of macroeconomics, growth, trade, international integration, and finance to present the results of their most recent research in a seminar format. The full list of seminars can be viewed here.

Event Details
  • Location: Washington, DC, World Bank Main Complex, MC10-100
  • Time: 12:30 - 2:00PM
  • CONTACT: Shweta Mesipam
  • smesipam@worldbank.org