Research

Working Papers

Asset Allocations and Returns in the Portfolios of the Wealthy with Julian Richers

Despite accounting for a large amount of total wealth, there is little direct empirical evidence of the investment behavior of wealthy households. Based on a proprietary database of investment portfolios and returns, we document three new facts about ultra-high net worth portfolios. First, asset allocations change strongly with total wealth, as super-wealthy households hold a much larger share of alternative investments, such as private equity and hedge funds, and a lower share of liquid assets, such as public equities. The data includes a significant number of portfolios large enough to explore allocations and returns within the top percentile of the wealth distribution, including the top 0.01 percent. Second, while realized returns are increasing with wealth, Sharpe ratios are broadly similar across the top of the wealth distribution. This suggests that investment skill does not differ among investors in upper portions of the wealth distribution, but that risk tolerance increases with total wealth. Third, we use the data to explore whether returns differ within narrow asset classes, and find that  returns on alternative assets in particular are increasing in wealth. This indicates that access and manager selection play a large part in determining returns and raises questions about the benefits of broadening access to delegated investing in private assets. Taken together, these findings substantially improve on existing empirical evidence on return heterogeneity in the U.S., which is increasingly understood to be critical in both macroeconomic dynamics and asset pricing.

Making Sense of Negative Rates with Yann Koby and Mauricio Ulate. SF Fed Working Paper 2022-12

Several advanced economies implemented negative nominal interest rates in the middle of the last decade, seeking to provide further monetary accommodation once cuts in positive territory had been exhausted. Negative rates affect banks in novel ways, mostly because during times of negative policy rates the interest rate that banks pay households on their deposits usually remains close to zero. In this review, we analyze the large literature that studies the impact of negative nominal interest rates, proceeding in four steps. First, we explain the theoretical channels through which negative rates affect banks. Second, we discuss the empirical findings about bank outcomes under negative rates. Third, we describe the aggregate transmission channels that influence the macroeconomic implications of a policy rate cut in negative territory. Finally, we compare the general-equilibrium models that have been used to quantify the effectiveness of negative rates and highlight why they have obtained mixed results. We conclude that, if properly implemented, negative rates are a valuable tool that central banks should not discard outright. However, negative rates can have quantifiable costs for the financial sector, and their effectiveness is likely to decline if implemented for long periods.

Leverage Limits in Good and Bad Times with Juanita Gonzalez-Uribe

How do leverage limits affect lending? We examine a regulatory change to the business development company (BDC) lending sector, which allowed lenders to double their regulatory leverage constraint. Exploiting the staggered timing of approvals, we show that this allowed firms to slowly adjust loan portfolios and increase leverage, but suddenly increase the unrealized losses reported on their loans. These patterns around approvals suggest that the slackness of regulatory constraints has important effects on lenders’ incentives to accurately assess fair value. In addition, we explore how the pandemic differentially affected BDCs that were close to or far from their leverage limits. Our results shed light on an important lending sector for small businesses, which has grown dramatically since the Great Recession.

Low Rates and Bank Loan Supply:  Theory and Evidence from Japan with Yann Koby [new draft]

What are the long-run consequences of low nominal interest rates? In this paper we (1) provide panel evidence from Japan of adverse effects on bank profitability and loan supply, (2) propose a macroeconomic model that rationalizes our key empirical findings and characterizes optimal long-run rates, and (3) discipline the model using panel evidence to estimate aggregate effects. Using banks' historical liability structure, we show exposed banks face relatively higher funding costs, have lower profitability, and decrease loan supply. In the model, market power in deposits helps mitigate lending frictions, but is sensitive to nominal rates due to cash. The optimal nominal rate is hence higher than suggested by the Friedman rule. Using bank heterogeneity to calibrate the model, we find that low rates resulted in significantly lower aggregate lending. Tiering bank reserves only marginally alleviates the negative effects of low rates on credit supply, while taxing cash is more effective.

Inflows and Spillovers: Tracing the Impact of Bond Market Liberalization [new draft]

This paper makes three contributions to understanding the macroeconomic impact of bond markets. Using evidence from reforms in Japan that gave borrowers selective access to bond markets, it shows that firms issued bonds to repay bank debt. Importantly, this led banks to increase lending to small and medium enterprises and real estate firms. Second, it proposes a model that demonstrates how bond markets can worsen the composition of bank borrowers and lower bank profitability. Third, the model shows that bond markets can amplify shocks to the risk-free rate and firm borrowing, raising concerns about the inherent stability of market-based finance.     

Default, Commitment, and Domestic Bank Holdings of Sovereign Debt

How do the incentives of domestic banks and sovereign governments interact? This paper presents a model of government default and banks that invest in the debt of their own sovereign. In the model, banks demand safe assets to use as collateral, and default affects bank equity. These losses inhibit banks' ability to attract deposits, leading to lower private credit provision, and lower output. This disincentivizes the sovereign from defaulting. The extent of output losses depends on characteristics of the banking system, including sovereign exposures, equity, and deposits. In turn, bank exposures are affected by default risk. The model is also used to show that policies such as financial repression can improve welfare, but worsen output losses in the event of default.

Bank-Firm Matching, Leverage, and Credit Quality [draft coming soon]

We observe considerable differences between banks in practice. What effects do these differences have, in theory? This paper explores the effect of bank heterogeneity on lending in a static assignment model, in which borrowers are assumed to be heterogeneous firms. Firms are assumed to differ in terms of productivity, and borrow from banks and uninformed investors in order to invest and produce. Banks are assumed to vary in terms of monitoring efficiency, and faced with the problem of deciding to whom to lend, among heterogeneous firms. The model is then used to explore patterns of bank-firm matching, and demonstrate why it may be that changes in the characteristics of banks and firms lead to changes in lending, leverage, and credit quality.

Book Chapters

A Restart Procedure to Deal with COVID-19 in Simeon Djankov and Ugo Panizza, eds.: Covid-19 in Developing Economies, 2020, CEPR E-Book. (with Simeon Djankov, Juanita Gonzalez-Uribe, and Dimitri Vayanos).

Governments around the world are assisting firms to deal with the adverse effects of Covid-19. Most forms of government assistance provided so far reduce firms’ operating costs. Firms’ debts keep accumulating, however, and the resulting debt overhang will be a drag on economic recovery. In this chapter we argue that policies are needed to restructure the debt of a large number of firms throughout the economy. We propose one such policy, which includes an extended bankruptcy stay, followed by a write-down of government claims on a firm conditionally on a comparable write-down agreed by the firm’s private creditors. Our procedure makes efficient use of fiscal resources, discourages healthy firms from claiming to be distressed, and can be combined with debt-equity swaps for large firms.