Optimal disclosure policy and undue diligence (Q2434343)

The paper under review is to explore the incentives that individual agents may discover the hidden information on their own at some cost. The authors model this undue diligence as a model of the threats of private information acquisition, the action to discover the hidden information is harmful from the perspective of our social welfare criterion. The asset in equilibrium serves as collateral for a short-term loan, and information that leads to a downward revision from bad news results in decreasing the asset's price, and tightening debt constraints. The credit crunch event can be avoided by suppressing news. In general, financial agencies do not disclose all the information they have to the assets under their control. Private firms are inclined not to report the current market value of their assets, bank regulators do not disclose their assessments of individual bank balance sheets under their supervision. The paper is to focus on the incentive for private information acquisition and to interpret different views that triggered the 2008 financial crisis. Section 2 gives the quasilinear model developed by \textit{R. Lagos} and \textit{R. Wright} [``A unified framework for monetary theory and policy analysis'', J. Polit. Econ. 113, No. 3, 463--484 (2005)] with an income-generating asset studied in [\textit{A. Geromichales} et al., ``Monetary policy and asset prices'', Rev. Econ. Dynam. 10, No. 4, 761--779 (2007)] to discover under what conditions a society will find it desirable to disclose the aggregate state and vice versa. Section 3 characterizes the set of incentive-feasible allocations under disclosure. Proposition 1 provides exact conditions under disclosure for the existence of an incentive-feasible allocation, and Proposition 2 shows the condition under disclosure under which the efficient night allocation is incentive-feasible. Section 4 characterizes the set of incentive-feasible allocations under nondisclosure. Proposition 3 shows conditions under nondisclosure for the existence of an incentive-feasible allocation, and Proposition 4 shows the condition under nondisclosure under which the efficient night allocation is incentive-feasible. Propositions 2 and 4 imply that the efficient allocation can be supported over a large range of values under nondisclosure. Section 5 analyzes the undue diligence under the communication switch-off. If the seller's SP (sequential participation) constraints and the NIC (no-inspection condition) are satisfied, then the efficient allocation is incentive-feasible by Propositions 5, 6 and 7. Section 6 derives the optimal constraint-efficient communication policy for different parameters. Proposition 8 obtains that the optimal communication policy is nondisclosure, and Proposition 9 shows that there is a critical parameter to separate the optimal communication policy to be disclosure or nondisclosure. The authors compare their results with others from the literature. Section 7 is devoted to interpretations of the 2008 financial crisis. The Gordon hypothesis states that the financial crisis is essentially a bank run that takes place when ``information-incentive'' debt suddenly becomes ``information sensitive'' owing to some shocks. The real estate prices drop surprisingly because of the subprime mortgage shock. The Isaac hypothesis is that the 2008 financial crisis is exacerbated by the ``transparency lay'' FAS rule 167. The third interpretation is that an incentive in macroeconomic uncertainty may in itself contribute to generate credit crisis phenomena. In the concluding Section 8, the authors summarize their findings. All technical proofs of the propositions are given in Appendix A. It would have been better to specify what role the regulators can play in this model, and to give the Markov transition probabilities associated to switch regions in the optimal disclosure policy.