[Popular Press: The FinReg Blog]
A New Draft (with substatial changes) is coming soon
Abstract: Consistent with the Minsky hypothesis and the "volatility paradox", recent empirical evidence suggests that financial crises tend to follow prolonged periods of financial stability and investor optimism. But does financial tranquility always call for stringent regulation over time? We examine this question using a simple portfolio choice model that features the interaction between externality and learning where learning could be biased in the sense of "diagonistic expecttaion". We evaluate the potential of a macroprudential policy to restore efficiency, and characterize the necessary and sufficient condition for the countercyclicality of the optimal regulation.
Presentation: (By one of the authors) IMF