The Regulatory Trade-Off in Real & Financial Markets

Bodo Herzog

doi:doi:10.11648/j.eco.20130203.11

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The Regulatory Trade-Off in Real & Financial Markets

Bodo Herzog

Published in Economics (Volume 2, Issue 3)

Received: 28 June 2013 Published: 30 July 2013

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Abstract

It remains undeniable that the regulatory framework in place prior to the financial crisis is built on a flawed system. But does this automatically suggest that more regulation is better? In general, we have to distinguish between the quantity and quality of rules and in particular, the enforcement. The last issue does not necessarily mean we need more regulation – sometimes a better enforcement is enough. Still there remains the question about the degree of regulation. This paper builds a new theory on the optimal degree of the regulatory trade-off. We elucidate the optimal degree of efficacy in financial regulation and compare it with the optimal degree in goods market regulation. We prove that financial regulation does not follow a simple economic trade-off by costs and benefits. In finance, the regulatory trade-off is a boundary solution, i.e. the efficient solution is either no regulation or comprehensive regulation. Either way you prefer, financial markets must be regulated differently in comparison to the real economy.

Published in	Economics (Volume 2, Issue 3)
DOI	10.11648/j.eco.20130203.11
Page(s)	17-22
Creative Commons	This is an Open Access article, distributed under the terms of the Creative Commons Attribution 4.0 International License (http://creativecommons.org/licenses/by/4.0/), which permits unrestricted use, distribution and reproduction in any medium or format, provided the original work is properly cited.
Copyright	Copyright © The Author(s), 2013. Published by Science Publishing Group

Keywords

Financial Regulation, Moral Hazard, Externalities and Optimality of Regulation

References

[1]	Brunnermeier, M.K., and L.H. Pedersen (2009). Market Liquidity and Funding Liquidity. Review of Financial Studies, 22(6), 2201-2238.
[2]	French, K.R. et al. (2010). The Squam Lake Report: Fixing the Financial System. Princeton University Press.
[3]	Bernanke, B. (2008). Reducing Systemic Risk. Speech at Federal Reserve Bank of Kansas City, Annual Economic Symposium, Jackson Hole, August 22, 2008.
[4]	Tirole, J. (2011). Illiquidity and All Its Friends. Journal of Economic Literature, 49:2, 287-325.
[5]	Freixas, X. and E. Gabillon (1999). Optimal regulation of a fully insured deposit banking system. Journal of Regulatory Economics, 15, 805-824.
[6]	Diamond, D. and P. Dybvig (1983). Bank runs, deposit insurance, and liquidity. Journal of Political Economy, 91(3), 401-419.
[7]	Crouhy, M. and D. Galai (1986). An economic assessment of capital requirements in the banking industry. Journal of Banking and Finance, 10, 231-241.
[8]	Kim, D. and A. Santomero (1988). Risk in banking and capital regulation. Journal of Finance, 43, 1219-1233.
[9]	Rochet. J. (1992). Capital requirements and the behaviour of commercial banks. European Economic Review, 36, 1137-1170.
[10]	Laffont, J. and J. Tirole (1986). Using cost observations to regulate firms. Journal of Political Economy, 94, 614-641.
[11]	Pindyck, R. and N. Wang (2009). The economic and policy consequences of catastrophes. MIT Sloan Working Paper, No 4751, 1-26.
[12]	Barro, R.J. (2009). Rare disaters and asset markets in the twentieth century. American Economic Reivew, 99(1), 243-254.
[13]	Parson, E.A. (2007). A review of Richard Posner’s catastrophe: Risk and response. Journal of Economic Literature, 45, 147-164.
[14]	Sunstein, C.A. (2007). Worst-Case Scenario. Harvard University Press.
[15]	Posner, R.A. (2004). Catastrophe: Risk and Response. Oxford University Press.

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APA Style

Bodo Herzog. (2013). The Regulatory Trade-Off in Real & Financial Markets. Economics, 2(3), 17-22. https://doi.org/10.11648/j.eco.20130203.11

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ACS Style

Bodo Herzog. The Regulatory Trade-Off in Real & Financial Markets. Economics. 2013, 2(3), 17-22. doi: 10.11648/j.eco.20130203.11

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AMA Style

Bodo Herzog. The Regulatory Trade-Off in Real & Financial Markets. Economics. 2013;2(3):17-22. doi: 10.11648/j.eco.20130203.11

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@article{10.11648/j.eco.20130203.11,
  author = {Bodo Herzog},
  title = {The Regulatory Trade-Off in Real & Financial Markets},
  journal = {Economics},
  volume = {2},
  number = {3},
  pages = {17-22},
  doi = {10.11648/j.eco.20130203.11},
  url = {https://doi.org/10.11648/j.eco.20130203.11},
  eprint = {https://article.sciencepublishinggroup.com/pdf/10.11648.j.eco.20130203.11},
  abstract = {It remains undeniable that the regulatory framework in place prior to the financial crisis is built on a flawed system. But does this automatically suggest that more regulation is better? In general, we have to distinguish between the quantity and quality of rules and in particular, the enforcement. The last issue does not necessarily mean we need more regulation – sometimes a better enforcement is enough. Still there remains the question about the degree of regulation. This paper builds a new theory on the optimal degree of the regulatory trade-off. We elucidate the optimal degree of efficacy in financial regulation and compare it with the optimal degree in goods market regulation. We prove that financial regulation does not follow a simple economic trade-off by costs and benefits. In finance, the regulatory trade-off is a boundary solution, i.e. the efficient solution is either no regulation or comprehensive regulation. Either way you prefer, financial markets must be regulated differently in comparison to the real economy.},
 year = {2013}
}

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TY  - JOUR
T1  - The Regulatory Trade-Off in Real & Financial Markets
AU  - Bodo Herzog
Y1  - 2013/07/30
PY  - 2013
N1  - https://doi.org/10.11648/j.eco.20130203.11
DO  - 10.11648/j.eco.20130203.11
T2  - Economics
JF  - Economics
JO  - Economics
SP  - 17
EP  - 22
PB  - Science Publishing Group
SN  - 2376-6603
UR  - https://doi.org/10.11648/j.eco.20130203.11
AB  - It remains undeniable that the regulatory framework in place prior to the financial crisis is built on a flawed system. But does this automatically suggest that more regulation is better? In general, we have to distinguish between the quantity and quality of rules and in particular, the enforcement. The last issue does not necessarily mean we need more regulation – sometimes a better enforcement is enough. Still there remains the question about the degree of regulation. This paper builds a new theory on the optimal degree of the regulatory trade-off. We elucidate the optimal degree of efficacy in financial regulation and compare it with the optimal degree in goods market regulation. We prove that financial regulation does not follow a simple economic trade-off by costs and benefits. In finance, the regulatory trade-off is a boundary solution, i.e. the efficient solution is either no regulation or comprehensive regulation. Either way you prefer, financial markets must be regulated differently in comparison to the real economy.
VL  - 2
IS  - 3
ER  -

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Author Information

Bodo Herzog

Economics Department, Institute of Finance and Economics (IFE), Reutlingen, Germany

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APA Style

Bodo Herzog. (2013). The Regulatory Trade-Off in Real & Financial Markets. Economics, 2(3), 17-22. https://doi.org/10.11648/j.eco.20130203.11

Copy | Download

ACS Style

Bodo Herzog. The Regulatory Trade-Off in Real & Financial Markets. Economics. 2013, 2(3), 17-22. doi: 10.11648/j.eco.20130203.11

Copy | Download

AMA Style

Bodo Herzog. The Regulatory Trade-Off in Real & Financial Markets. Economics. 2013;2(3):17-22. doi: 10.11648/j.eco.20130203.11

Copy | Download

@article{10.11648/j.eco.20130203.11,
  author = {Bodo Herzog},
  title = {The Regulatory Trade-Off in Real & Financial Markets},
  journal = {Economics},
  volume = {2},
  number = {3},
  pages = {17-22},
  doi = {10.11648/j.eco.20130203.11},
  url = {https://doi.org/10.11648/j.eco.20130203.11},
  eprint = {https://article.sciencepublishinggroup.com/pdf/10.11648.j.eco.20130203.11},
  abstract = {It remains undeniable that the regulatory framework in place prior to the financial crisis is built on a flawed system. But does this automatically suggest that more regulation is better? In general, we have to distinguish between the quantity and quality of rules and in particular, the enforcement. The last issue does not necessarily mean we need more regulation – sometimes a better enforcement is enough. Still there remains the question about the degree of regulation. This paper builds a new theory on the optimal degree of the regulatory trade-off. We elucidate the optimal degree of efficacy in financial regulation and compare it with the optimal degree in goods market regulation. We prove that financial regulation does not follow a simple economic trade-off by costs and benefits. In finance, the regulatory trade-off is a boundary solution, i.e. the efficient solution is either no regulation or comprehensive regulation. Either way you prefer, financial markets must be regulated differently in comparison to the real economy.},
 year = {2013}
}

Copy | Download

TY  - JOUR
T1  - The Regulatory Trade-Off in Real & Financial Markets
AU  - Bodo Herzog
Y1  - 2013/07/30
PY  - 2013
N1  - https://doi.org/10.11648/j.eco.20130203.11
DO  - 10.11648/j.eco.20130203.11
T2  - Economics
JF  - Economics
JO  - Economics
SP  - 17
EP  - 22
PB  - Science Publishing Group
SN  - 2376-6603
UR  - https://doi.org/10.11648/j.eco.20130203.11
AB  - It remains undeniable that the regulatory framework in place prior to the financial crisis is built on a flawed system. But does this automatically suggest that more regulation is better? In general, we have to distinguish between the quantity and quality of rules and in particular, the enforcement. The last issue does not necessarily mean we need more regulation – sometimes a better enforcement is enough. Still there remains the question about the degree of regulation. This paper builds a new theory on the optimal degree of the regulatory trade-off. We elucidate the optimal degree of efficacy in financial regulation and compare it with the optimal degree in goods market regulation. We prove that financial regulation does not follow a simple economic trade-off by costs and benefits. In finance, the regulatory trade-off is a boundary solution, i.e. the efficient solution is either no regulation or comprehensive regulation. Either way you prefer, financial markets must be regulated differently in comparison to the real economy.
VL  - 2
IS  - 3
ER  -

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