Market Discipline for Financial Institutions and Markets for Information
52 Pages Posted: 16 Jul 2011
Date Written: April 15, 2011
This study analyzes the causes of the market discipline failure in the recent financial crisis. We argue that the most important market failure of informativeness was that large financial institutions had the incentive to remain opaque strategically so that outside investors could not assess their solvency. We also discuss how different debt-based and equity-based financial instruments provide more or less timely information by illustrating the behavior of different financial instruments (e.g., stock price indexes, credit default swaps and subordinated debt) around events associated with insolvency of some financial institutions during the 2007-2009 financial crisis. Our paper concludes by laying out four “informativeness principles” for regulators and policy makers to follow with the objective to strengthen the incentives of market participants to acquire, analyze, disclose and signal information.
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