Bank Capital for Market Risk: A Study in Incentive-compatible Regulation
Traditionally, government regulation in the United States follows a straightforward command approach. The government states the desired activities of the regulated firm, the allowable actions, and the prohibited actions. The firm is punished if it violates these strictures. Regulatory economists have identified many problems with this approach. First, there is the problem of asymmetry in information: Regulations cannot be enforced if they require information from the firm that the regulator cannot elicit reliably and at reasonable cost.