Working Papers
Manipulating Non-Fundamental Information (with Xingtan Zhang, Wei Zhou, and Shrihari Santosh) [SSRN]
Revise and Resubmit at Journal of Finance
Non-fundamental trading motives drive significant and persistent flows in financial markets. This paper examines how an informed trader exploits information related to these flows. The informed trader faces a time-varying trade-off between immediately exploiting current non-fundamental information and creating additional information in the future. Exploitation stabilizes current prices by partially absorbing contemporaneous flows, while manipulation pushes other traders' beliefs about future flows further away from the truth. When the second motive dominates, the informed trader incurs short-term losses by trading in the same direction as non-fundamental flows today. This exacerbates rather than mitigates mispricing, magnifying return reversals.
Comparables-Constrained Asset Prices (with Jordan Martel and Edward Van Wesep) [SSRN ]
Revise and Resubmit at Management Science
We develop a model of asset pricing in which buyers are either unable or unwilling to buy an asset at a price substantially above its price in recent transactions. This constraint could result from legal restrictions on appraisals, behavioral preferences, or agency problems. The model features momentum, differential pricing for identical assets, buyers' and sellers' markets, and associations between price appreciation, volume, and liquidity. We apply the model to the market for residential real estate, in which a bank's willingness to lend for a home purchase is limited by the appraisal, which is, in turn, generated by recent transaction prices of similar properties. The model's predictions are consistent with known stylized facts in residential real estate markets and suggest several avenues for future research.
When Toothless Caps Bite: Complementarities and Collapse in Rent-Controlled Markets (with Jordan Martel and Edward Van Wesep)
We model a market with rent controls and identify a novel problem: rent controls can create worries about future availability of units that drive rents today. A new rent cap above the market level can drive rents up to that cap. If only a fraction of units are capped, those units can see rents rise while the remaining market-rate units will see rents rise even more. This calls into question empirical designs meant to test the effects of rent control policies on prices. While rent-controlled units will, trivially, have weakly lower rents than identical non-capped units, rents for both types of unit may be higher than would obtain if rent controls were eliminated entirely. Importantly, the novel tension that we model is first order. It is certainly top of mind for renters in markets with widespread rent controls, like New York City. The effect of controls -- above or below counterfactual market rates -- on liquidity, arising from forward-looking concerns, is of a higher order of magnitude than the effect suggested by a standard hedonic demand framework.
Published and Accepted Papers
Dynamic microlending under adverse selection: Can it rival group lending? (with Christian Ahlin) [Link]
Journal of Development Economics, July 2016.
We derive an optimal lending contract in a two-period adverse selection model with limited commitment on the borrower side. The contract involves "penalty" interest rates after default, and favorable rates after success. Under some conditions, it also charges first-time borrowers higher rates than repeat borrowers, as in "relationship lending", because the lender is constrained to keep borrowing attractive while using revealed information to price for risk. We compare the efficiency of a group lending contract (of the kind popularized by the microcredit movement) to the dynamic, individual contract. Both types of contracts reveal the same information, but the contracts face different constraints on using the information to improve risk-pricing. As a result, either type of contract can lead to greater efficiency depending on specifics of the environment - opening the possibility that dynamic lending has played a role comparable to that of group lending in the success of microcredit. We also characterize the optimal dynamic group contract when both lending techniques are feasible, and find that it combines both approaches, but with varying emphases. A recurrent theme is that in more marginal environments, dynamic lending performs relatively better than, and is prioritized over, group lending. We also discuss a number of extensions, including (spatially and serially) correlated risk and the effect of competition.
Review of Financial Studies, March 2019.
We study joint financing between profit-motivated and socially-motivated (impact) investors and derive conditions under which impact investments improve social outcomes. When project owners cannot commit to social objectives, impact investors hold financial claims to counterbalance owners' profit motives. Impact investors' ownership stakes are increasing in their value of social output, and pure nonprofit status may be optimal for the highest valued social projects. We provide guidance into the design of contingent social contracts such as social impact bonds and social impact guarantees.
Media: So You Want to Invest to Make Impact, How innovation in financial security design may boost impact investing in 2015, Investing for Impact - Harvard Law School Forum on Corporate Governance and Financial Regulation
Learning by Owning in a Lemons Market (with Jordan Martel and Kenneth Mirkin) [Link] [SSRN] [Slides]
Journal of Finance, June 2022.
We study market dynamics when an owner learns over time about the quality of her asset. Since this information is private, the owner sells strategically to a less informed buyer following sufficient negative information. In response, market prices feature a "U-shape" and trading probabilities a "hump-shape" with respect to the length of ownership prior to sale. As the owner initially acquires greater private information, buyers suffer greater adverse selection, and prices fall accordingly. Eventually, the probability of an informed sale shrinks, and prices subsequently rebound. We provide evidence consistent with our model in the markets for residential real estate, venture capital investments, and construction equipment.
Bonus season: A theory of periodic labor markets and coordinated bonuses (with Edward Van Wesep) [Link] [SSRN] [Slides]
Management Science, July 2022.
We present a general equilibrium model in which firms and workers coordinate compensation so that turnover is high in some periods and low in others. This ensures that firms and workers typically search for new matches when other firms and workers are available. If firms and workers find themselves in a periodic equilibrium, contracts often feature large bonuses paid just prior to periods of high labor market turnover. The theory's predictions match stylized facts concerning compensation and turnover in high finance and biglaw.
On the Magnification of Small Biases in Hiring (with Shaun Davies and Edward Van Wesep) [LINK ] [SSRN]
Journal of Finance, October 2024.
Best Paper Prize, ASU Sonoran Winter Finance Conference 2020
We analyze a setting in which a board must hire a CEO after exerting effort to learn about the quality of each candidate. Optimal effort is asymmetric, implying asymmetric likelihoods of each candidate being chosen. If the board has a bias in favor of one candidate, it selects an effort allocation that maximizes the likelihood of that candidate being chosen. Even when the board's prior is that its preferred candidate is inferior, that candidate may still be chosen most often. A glass ceiling can also arise, in which the tendency to hire favored candidates increases as the importance of the position increases.
Media: Finance Theory Insights
The Sky's the Limit: Asset price spirals when margin traders are all in (with Edward Van Wesep) [SSRN]
Forthcoming at Review of Asset Pricing Studies
We analyze a setting in which some investors are all in and buy as much of a risky asset as their margins allow. A higher price of the asset increases all-in investors' wealth, against which they borrow to buy more shares. If all-in investors have enough wealth and access to at least 2:1 leverage, then prices can spiral upward indefinitely. This is true even if there exist deep-pocketed investors with no explicit limits to arbitrage. Increasing access for retail investors to leverage through leveraged ETFs, derivatives, and margin suggests increasing opportunities for price spirals and collapses.