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In this paper, EDHEC-Risk compares the effects of different regulatory measures used to reduce excess volatility of stock-market returns, which is generated by investors trading on sentiment.
The main contribution of this research is to evaluate the regulatory measures within the same dynamic, stochastic general equilibrium model of a production economy, so that one can compare both the direct and indirect effects of the different measures on the financial and real sectors within the same economic setting.
EDHEC-Risk finds that of the three measures they consider, only the leverage constraint is effective in reducing stock-market volatility, and this is accompanied by positive effects on the real sector: an increase in the levels of consumption growth and investment growth, and a decrease in their volatilities. In contrast, both the Tobin tax and shortsale constraints increase volatility in financial markets, and have negative effects on the real sector: a decrease in the growth rates of output and investment and an increase in the volatility of consumption-growth.