RESEARCH
[Published Papers]
Disclosure Services and Welfare Gains in Matching Markets for Indivisible Assets (2024), Review of Economic Design, https://doi.org/10.1007/s10058-024-00352-2
We present a competitive matching model in which indivisible assets are reallocated among many traders. The model has three features: (i) traders are heterogeneous in their prospects as buyers, sellers, and also in their stand-alone values with endowed assets, (ii) buyers do not know true values of assets sold, (iii) sellers can disclose values of their assets by paying fees. Despite its complexity, the model admits closed-form solutions. Two main results emerge. First, if full disclosure is facilitated by a monopolist, it captures a large fraction of the welfare gains. Second, adding the option of minimum disclosure, when combined with a cap regulation on price-dependent fees for full disclosure, significantly weakens the monopolist's power.
Welfare Consequences of Information Aggregation and Optimal Market Size (2017), American Economic Journal: Microeconomics, 9 (4), pp. 303-323
We analyze the welfare implications of information aggregation in a trading model where traders have both idiosyncratic endowment risk and asymmetric information about security payoffs. The optimal market size balances two forces: (i) the risk-sharing role of markets, which creates a positive externality amongst traders, against (ii) the information-aggregation role of prices, which leads to prices that are more correlated with security payoffs, thereby undermining the hedging function of markets. Our analysis indicates that a market with infinitely many traders may not be the right welfare benchmark in the presence of risk aversion and information aggregation.
(PDF) (Online appendix)
Market Size Matters: A Model of Excess Volatility in Large Markets (2016), Journal of Financial Markets, 28, pp. 24–45
We present a model of excess volatility based on speculation and equilibrium multiplicity. Each trader has two distinct motives to trade: (i) speculation based on noisy signals, and (ii) hedging against endowment shocks. The key to equilibrium multiplicity is the self-fulfilling nature of information aggregation: if individuals trade relatively more on the basis of speculation rather than hedging, then prices reveal more information on payoff risk which in turn justifies less need for hedging. We first show that multiplicity arises only in large markets where aggregate shocks in prices are sufficiently more important than idiosyncratic shocks. We then show that (i) in a given equilibrium, excess volatility increases with payoff volatility, (ii) comparing across different equilibria, excess volatility is negatively associated with liquidity, trading volume, and social welfare. We also show that an increase in market size either creates high-volatility equilibria or eliminates low-volatility equilibria. Among other things, the model predicts that given two assets identical in their fundamental properties, the one that attracts more traders overtime is more likely to experience a jump in excess volatility.
(PDF) (Online appendix)
Posterior Renegotiation-Proofness in a Two-Person Decision Problem (2016), International Journal of Game Theory, 45 (4), pp. 893–931
When two agents with private information use a mechanism to determine an outcome, what happens when they are free to revise their messages and cannot commit to a mechanism? We study this problem by allowing agents to hold on to a proposed outcome in one mechanism while they play another mechanism and learn new information. A decision rule is posterior renegotiation-proof if it is posterior implementable and robust to a posterior proposal of any posterior implementable decision rule. We identify conditions under which such decision rules exist. We also show how the inability to commit to the mechanism constrains equilibrium: a posterior renegotiation-proof decision rule must be implemented with at most five messages for two agents.
(PDF)
Conditional Forecast Selection from Many Forecasts: An Application to the Yen/Dollar Exchange Rate (2013), Journal of The Japanese and International Economies, 28, pp. 1–18
This paper proposes a new method for forecast selection from a pool of many forecasts. The method uses conditional information as proposed by Giacomini and White (2006). It also extends their pairwise switching method to a situation with many forecasts. I apply the method to the monthly yen/dollar exchange rate and show empirically that my method of switching forecasting models reduces forecast errors compared with a single model.
(PDF)
[Accepted Papers]
A Quick Route to Powers of Sums
We derive a formula for powers of sum. A simple proof by mathematical induction shows that any powers of sum (i.e., (∑i)²,(∑i)³,...) can be expressed as the weighted average of sums of odd powers (i.e., ∑i³, ∑i⁵,...), where the weights add up to one.
(PDF)
[Working Papers]
A Model of Self-Selection in the Takeover Market
We develop a self-selection model of takeovers in which tradeable "projects" and non-tradeable "organizations" are complements. Without distortions, a positive cross-partial condition generates the monotonic self-selection. With distortions, we derive a stronger complementarity condition sufficient for the monotonic self-selection. The monotonicity implies that signs of announcement returns identify a type of pre-announcement public information about firms. We discuss stylized facts about announcement returns through the lens of our model. A parameterized model shows that the relative bidder size increases in the importance of organizations in production, and also in the level of distortions if organizations are sufficiently important in production.
(PDF) (Slides) (Short slides)
Dissecting Return Regressions: The Role of Pre-Investment Firm Values
We derive a formula that decomposes the marginal effect of pre-investment firm values on realized returns into an economic effect and a mechanical effect, taking into account the endogeneity of investment. It reveals that regressing realized returns on pre-investment firm values results in a biased estimate of the economic effect and that the bias direction and magnitude depends on relative investment size and realized returns. For data with positive returns, correcting the bias is straightforward. For data in which returns take both signs, such as takeovers, stronger assumptions are necessary to interpret return regressions. We make suggestions for circumventing this issue.
Reallocation of the Intermediation Risk: The Role of Interbank Markets and Interest on Reserves in the Macroeconomy
(joint with Shuyun May Li)
We present a theory of the interbank market, where banks are risk averse and subject to idiosyncratic intermediation risk. Because banks face heterogeneous risk-return trade-offs, there are gains from reallocating loans among banks. In a partial equilibrium setup, the model admits closed form solutions for bank variables, allowing for their comparative statics with respect to the level of bank risk aversion and interest on reserves (IOR). We embed the interbank market in a simple general equilibrium model to measure its contribution to welfare. The interbank loan trading significantly increases banks' risk-taking, thereby increasing production and the household consumption. The average household consumption in a stochastic steady state increases by 13.56% -- 23.53%, depending on the treatment of the intermediation loss. At the same time, the interbank market raises volatility of production and consumption. These real effects of the interbank market become smaller when IOR is increased.
The Risk Sharing Benefit versus the Collateral Cost: The Formation of the Inter-Dealer Network in Over-the-Counter Trading
(joint with Zhuo Zhong)
The decentralized over-the-counter (OTC) market generates a trading network among dealers. We model the driver behind the formation of this inter-dealer network as the need for dealers to share risk. The trade-off between the benefit of risk-sharing and the funding cost of collateral determines the shape of the inter-dealer network. In equilibrium, dealers' markups and trading volumes increase with the number of links they have to other dealers, whereas dealers' inventory risks decrease as they form links. In addition, when capacity of providing liquidity differentiates dealers, the network formed exhibits the empirically observed core-periphery structure: dealers with large capacity comprise the core of the network, connecting them to all other dealers, while dealers who have small capacity operate at the periphery. The model matches recent empirical findings on the negative relationship between order sizes and markups. More importantly, we show that there may be structural breaks in this negative relationship as variations in order sizes may alter the inter-dealer network. These results suggest that empirical studies on OTC markets should control for the stability of an interdealer network to avoid model misspecification.
(under significant revision)
Identifying Trading Motives in A Linear-Quadratic Model
A quadratic-normal model has been a workhorse model in finance. While it can be derived from a CARA preference, some recent papers use risk-neutral traders facing an inventory cost to generate a quadratic-normal structure. So far, a relationship between the two models has been unclear. Using a simple framework nesting both models, I highlight a key economic difference between the two models, and demonstrate that they can produce distinct predictions with respect to price informativeness, volatility, volume, and price impact in response to a change in public information. Implications of the results for an identification of trading motives are discussed.
(PDF)
Excessive Dynamic Trading: Propagation of Belief Shocks in Small Markets
Can belief shocks make trading excessive? We present a dynamic inventory management model in which belief shocks gradually propagate across traders, leading to the inflated trading activity which reduces traders' welfare. Trading can be socially beneficial because smoothing heterogeneous asset positions saves inventory costs. Without belief shocks, traders focus on the socially beneficial trading and the dispersion of the asset positions decreases monotonically. We show that one-shot belief shocks induce a speculative trading, which aggregates information but slows down the convergence of the asset positions. When traders' beliefs change quickly, the dispersion of the asset positions goes up, creating a cyclical pattern in volume. We also show that the high frequency trading amplifies the impact of belief shocks by making the speculation less costly, and therefore steering traders away from the socially beneficial trading motive.
(PDF)
[Work-in-Progress]
Defying Gravity: The Role of Intermediaries for Cross-Border Mergers and Acquisitions
(joint with Banri Ito and Junhyung Ko)
This study examines the determinants of cross-border mergers and acquisitions (M&A) using the gravity approach. We show that a relatively high presence of M&A advisers is conductive to M&A, particularly for cross-border deals, and their impacts are pronounced in acquirer countries. Further, for acquirer countries, we find substitutability between the use of MYA advisers and the extent of financial development for financial institutions and markets, whereas complementarities exist for target countries.
(Slides)