Inside and outside information

Journal article

We study an economy with financial frictions in which a regulator designs a test that reveals outside information about a firm's quality to investors. The firm can also disclose verifiable inside information about its quality. We show that the regulator optimally aims for “public speech and private silence,” which is achieved with tests that give insiders an incentive to stay quiet. We fully characterize optimal tests by developing tools for Bayesian persuasion with incentive constraints, and use these results to derive novel guidance for the design of bank stress tests, as well as benchmarks for socially optimal corporate credit ratings.

Authors: Quigley, D; Walther, A

• Publication status: Published
• Peer review status: Peer reviewed
• Publisher: Wiley
• Journal: Journal of Finance
• Volume: 79
• Issue: 4
• Pages: 2667-2714
• Publication date: 2023-06-10
• Acceptance date: 2023-07-04
• DOI: 10.1111/jofi.13360
• EISSN: 1540-6261
• ISSN: 0022-1082
• Language: English