RESEARCH


Asset pricing with frictions; Financial institutions; Contract theory; Information economics.



WORKING PAPERS


Self-selection in Mutual Fund Strategies.
(with Apoorva Javadekar)   [coming soon]


Institutional Investors, Heterogeneous Benchmarks and the Comovement of Asset Prices. 
(with Idan Hodor)   [download PDF]

Abstract
We study the equilibrium implications of a multi-asset economy in which asset managers are subject to different benchmarks, and demonstrate how heterogeneous benchmarking generates a mechanism through which fundamental shocks propagate across assets. Fluctuations in asset managers' capital invested for benchmarking purposes, scaled by the size of the economy, induce price pressure that can result in negative spillovers across asset returns. We highlight the economic significance of these benchmarking-induced spillovers by analyzing shock elasticities and cross-elasticities of price-dividend ratios, and characterize a rich structure of asset price comovements within and across benchmarks. Heterogeneous benchmarking also induces return predictability, generating both reversal and momentum.


A Theory of Model Sophistication and Operational Risk
. 
(with Suleyman Basak)   [download PDF]

AbstractWe study the decision making of a financial institution in the presence of a novel implementation friction that gives rise to operational risk. Operational risk naturally arises whenever the institution faces a trade-off between adopting a more sophisticated investment model and one that is less complex to implement. In practice, a more sophisticated model generates a more informative signal about an investment opportunity by relying on the latest IT infrastructure and advanced data analytics, but the use of these technologies makes it more prone to operational errors. In this case, it is no longer optimal to adopt the most sophisticated model available, and endogenous deviations from it are affected in opposite ways by the various risks the institution faces. While operational risk and market risk induce adopting a less sophisticated model, model risk induces adopting a more sophisticated one. The negative relation between operational risk and model sophistication implies that the institution's optimal operational exposure may well become decreasing in the level of operational risk, and that its optimal market exposure becomes less volatile.


Asset Management Contracts and Equilibrium Prices
.
(with Dimitri Vayanos and Paul Woolley)   [download PDF]
Revise and Resubmit American Economic Review.

Best Paper Award in Asset Pricing, SFS Finance Cavalcade 2015.

Press Coverage
:
The Economist | Financial Times | Businessweek

Abstract
We study the joint determination of fund managers' contracts and equilibrium asset prices. Because of agency frictions, investors make managers' fees more sensitive to performance and benchmark performance against a market index. This makes managers unwilling to deviate from the index and exacerbates price distortions. Because trading against overvaluation exposes managers to greater risk of deviating from the index than trading against undervaluation, agency frictions bias the aggregate market upwards. They can also generate a negative relationship between risk and return because they raise the volatility of overvalued assets. Socially optimal contracts provide steeper performance incentives and cause larger pricing distortions than privately optimal contracts.


Systemic Risk Management.   
[
new version coming soon]

Best Young Researcher Award, Multinational Finance Society 2013.

AbstractWe study the dynamics of risk management of systemically important financial institutions. Financial distress triggers a resolution regime, which gives rise to a costly renegotiation process among claim-holders. As a source of systemic externality, renegotiation becomes more costly when other institutions are in distress at the same time. This affects financial institutions' incentives to take risk and strategically manage it over time, and mandates an analysis of their endogenous asset choices in coalescence. We derive a unique strategic equilibrium in which two leveraged financial institutions adopt polarized and stochastic risk management policies, without sacrificing full diversification. The systemic component of risk management reduces the correlation between the institutions' assets, and may induce the less capitalized institution to become negatively correlated with the market. We further show that systemic risk management can be implemented by trading CDS written on the other institution, and we analyze implications for debt pricing and the likelihood of systemic events. 


Unintended Consequences of Post-Trade Transparency
.   
[new version coming soon]

AbstractPost-trade transparency is meant to provide market participants with more information, thus to enhance the efficiency and liquidity of the market. In a dynamic model of strategic informed trading, we study the implications of mandatory disclosure of corporate insider trades (as ruled in Section 16(a) of the U.S. Securities Exchange Act). In a more transparent market, an insider optimally reduces the informational content of her trades by adopting a less aggressive and noisy trading strategy.  In equilibrium, post-trade disclosure reduces informational efficiency of prices, may cause the market to be less liquid, and may even be beneficial to the informed trader. We characterize explicitly the unintended consequences of post-trade transparency by deriving the ensuing efficiency and liquidity losses. 



PUBLICATIONS IN REFEREED JOURNALS


Should Insider Trading be Prohibited when Share Repurchases are Allowed? 
(with Giovanna Nicodano), Review of Finance 12(4), 2008, 735–765.   [download PDF]

Strategic Insider Trading with Imperfect Information: A Trading Volume Analysis
Rivista di Politica Economica XI-XII, 2004, 101–143.   [download PDF]



WORK IN PROGRESS


Information Diffusion and Equilibrium Prices with Fast Traders. 
(with Jerome Detemple and Marcel Rindisbacher)

The Indirect Cost of Active Fund Management.
(with Yunjeen Kim and Gustavo Schwenkler)

Contingent Capital and Optimal Asset Choice.