Upcoming presentations, discussions and general updates

• Jan 8, 2023: Presenting "Monetary Policy and Fragility in Corporate Bond Funds" at the AFA annual meeting

• Jan 8, 2023: Discussing "Corrective Regulation with Imperfect Instruments" by Davila and Walther at the AEA annual meeting

• Mar 10, 2023: Presenting "Monetary Policy and Fragility in Corporate Bond Funds" at Bank of England

Working papers

Dealer Funding and Market Liquidity (with Max Bruche) (REVISED!) [paper on SSRN]

Revise and resubmit, Management Science 

Abstract:  We consider a model in which dealers intermediate trades between clients and provide immediacy, or, market liquidity. Dealers can exert unobservable search effort to improve the chance of intermediating profitably.  This moral-hazard friction impairs dealers’ ability to raise external finance and hence to compete aggressively with each other in providing liquidity. Market liquidity is limited even for safe assets and more so for assets with higher search cost. To alleviate the financing friction, dealers opt to finance with debt and intermediate in several markets simultaneously. Dealer leverage is therefore endogenous and related to variations in liquidity across otherwise unrelated markets. Our results shed light on how post-crisis regulations influence the provision of immediacy in bond markets.

Publications

Self-fulfilling Fire Sales: Fragility of Collateralized Short-term Debt Markets + Internet Appendix

The Review of Financial Studies (2021) 34.6: 2910-2948

Abstract: This paper shows that collateralized short-term debt, although privately optimal for reducing borrowers' risk-taking incentive, can cause fragility (multiple equilibria). Hence, despite first-come-first-served constraint being absent in collateralized debt such as repurchase agreements (repo), a systemic run can arise, featuring large increases in default risks, fire-sale discounts of collateral, cost of credit, and amount of credit rationing. Policies such as asset-price guarantee, leverage cap, and central clearing can promote stability and welfare. Using global-game techniques, I show that a systemic run is more likely in bad times and a large enough asset-price guarantee reduces run risks.

Funding Constraints and Informational Efficiency (with Sergei Glebkin and Naveen Gondhi)

The Review of Financial Studies (2021) 34.9: 4269-4322

Abstract: We analyze a tractable rational expectations equilibrium model with margin constraints. We argue that constraints affect and  are affected by informational efficiency, leading to a novel amplification mechanism. A decline in wealth tightens constraints and reduces investors' incentive to acquire information, lowering price  informativeness. Lower informativeness, in turn, increases the risk borne by financiers who fund trades, leading them to further tighten constraints faced by investors.  This information spiral leads to (a) significant increases in risk premium and return volatility in crises, when investors’ wealth declines,  (b) complementarities in information acquisition in crises, and (c) complementarities in margin requirements.

Securitization and Optimal Foreclosure​ (with Jing Zeng)

Journal of Financial Intermediation (2021) 48: 100885.

Abstract: Does securitization distort the foreclosure decisions of non-performing mortgages? In a model of mortgage-backed securitization with an endogenous foreclosure policy, we find that the securitizing bank adopts a tougher foreclosure policy than the first-best, despite resulting in higher loan losses. This is optimal because foreclosure mitigates the adverse selection problem in securitization by making the optimal security, a risky debt, less information-sensitive. We further show that policies that limit mortgage foreclosure would discourage the bank's ex ante screening effort, reducing the quality of securitized mortgages. Our model yields novel testable predictions on the effect of mortgage securitization on foreclosure rates, loan performance, and mortgage servicing.

When Large Traders Create Noise (with Sergei Glebkin) 

Accepted, Journal of Financial Economics 

Abstract: We consider a market where large investors do not only trade on information about asset fundamentals. When they trade more aggressively, the price becomes less informative. Other investors who learn from prices, in turn, are less concerned about adverse selection and provide more liquidity, causing large investors to trade even more aggressively. This trading complementarity can engender three unconventional results:  i) increased competition among large investors makes all investors worse off, ii)  more precise private information reduces price informativeness, creating complementarities in information acquisition, and iii) multiple equilibria emerge. Our results have implications for competition and transparency policies in financial markets.

The Design of a Central Counterparty (with Vincent Maurin) (REVISED!)

Accepted, Journal of Financial and Quantitative Analysis 

Abstract: This paper analyzes the optimal allocation of losses via a Central Clearing Counterparty (CCP) in the presence of counterparty risk. A CCP can hedge this risk by providing loss-absorbing capital or by mutualizing losses among its members. This protection, however, weakens members' incentives for risk management. Delegating members'  risk monitoring to the CCP alleviates this tension in large markets. To discipline the CCP at minimum cost, members offer the CCP a junior tranche and demand capital contribution. Our results thus endogenize the default waterfall and deliver novel predictions on its composition, collateral requirements, and CCP ownership structure.

Work-in-progress

Monetary policy and corporate bond fund fragility (with Jinyuan Zhang)