Competition in Opaque Markets and Policy Trap

This paper proposes a new channel of inefficient investment crowding of sophisticated investors, and shows how to mitigate the inefficiency through optimal use of aggregate information observed by a regulator. The new channel is that the investors are uncertain about the extent of crowding. We analyze the optimal disclosure policy of the amount of capital committed to investment opportunities. Interestingly, we find that it is suboptimal to perfectly disclose the capital amount in order to mitigate the crowding. We also show that implementation of the optimal disclosure policy requires regulator's commitment to partial intervention to avoid a policy trap