2014): “Should Banks’ Stress Test Results be Disclosed? An Analysis

tions, and members of the Committee on Capital Markets Regulation for helpful comments. The argument for disclosing banks ’ stress test results is that it improves market disci-pline. Market discipline, in turn, improves resource allocation in the economy. In this paper, we argue that, market discipline is a necessary but not sufficient condition for economic effi-ciency. We highlight three potential endogenous costs of disclosing banks ’ stress test results. First, while these disclosures might improve price efficiency and hence market discipline, they might also induce sub-optimal ex ante decisions in financial institutions. Second, these disclosures might induce ex post market externalities that lead to excessive and inefficient re-action to public news. Third, such disclosures might also reduce traders ’ incentives to gather information, which reduces market discipline because it hampers the ability of regulators to learn from market data for their regulatory actions. Overall, we believe that disclosure of stress test results is beneficial because it promotes financial stability. However, in promoting financial stability, disclosure of stress tests re-sults may exacerbate bank-specific inefficiencies. We provide some guidance on how such inefficiencies could be minimized.