Research

Publications

When Transparency Improves, Must Prices Reflect Fundamentals Better? with Snehal Banerjee and Jesse Davis, Review of Financial Studies 2017, Forthcoming 

Abstract: To ensure asset prices better reflect fundamentals, public policy often aims to improve access to information. We show that such policy can be counterproductive. We study the optimal decision of arbitrageurs who choose to learn about asset fundamentals and the intensity of feedback trading by others, subject to an information capacity constraint. Making learning easier, even if exclusively about fundamentals, can make prices less efficient. In fact, when investors' information capacity is sufficiently high, we show that increasing this capacity further always decreases efficiency. Providing public information directly, either about fundamentals or about other traders, can have a similar effect.

Working Papers

(New) Feedback Effect and Investor Information Acquisition: Implications for Agency Problems  with Jesse Davis 

Abstract: Financial markets reveal information through which firm managers increase the value of equity, e.g., by improving investment decisions. With debt, however, such decisions are not necessarily socially efficient.  We demonstrate that investors' endogenous information acquisition, acting through this feedback channel, attenuates risk-shifting but amplifies debt overhang. The most ex-ante inefficient examples of risk-shifting encourage information acquisition, lowering the likelihood such projects are chosen inefficiently ex-post. The logic reverses with debt overhang: more efficient projects discourage information acquisition, increasing the ex-post likelihood they are foregone. Our model provides a novel channel through which financial markets impact agency frictions between firm stakeholders.


(New) Funding constraints and Informational Efficiency  with Sergei Glebkin and John Kuong 

Abstract: We develop a tractable rational expectations model that allow for general portfolio constraints. We apply our methodology to study a model where constraints arise due to endogenous margin requirements. We argue that margin requirements affect and are affected by informational efficiency, leading to a novel amplification mechanism. A drop in investors' wealth tightens constraints and reduces their incentive to acquire information, which lowers price informativeness. Moreover, financiers who use information in prices to assess the risk of financing a trade face more uncertainty and set tighter margins, which further tightens constraints. This \textit{information spiral} implies that risk premium, conditional volatility and sharpe ratios rise disproportionately as investors' wealth drops. Our model uncovers a new, information-based rationale why the wealth of investors is important.


 

Rational Inattention, Misallocation, and Asset Prices
 
2016 Cubist Systematic Strategies Award at WFA
Abstract: I develop a highly tractable general equilibrium model in which firms face attention constraints, and study the effect of rational inattention on misallocation, asset prices and real quantities. I allow for two types of uncertainty, firm-specific and economywide. Managers have a finite information processing capacity to reduce uncertainty about these two types of shocks. An increase in aggregate uncertainty leads to a reallocation of capacity from learning about firm-specific shocks to learning about the aggregate state, leading to higher misallocation of resources across firms and lower output. An increase in idiosyncratic uncertainty has the converse effect and results in an economic expansion. My model delivers testable predictions regarding the degree of aggregate resource misallocation, the relation between uncertainty and output, and the comovement of production inputs and stock prices across firms, which I confirm in the data.

Old Working Papers

Coordination Risk and Limits to arbitrage

Abstract: Why doesn't price move back to the fundamental value after a non-fundamental demand/supply shock? In this paper, I present a model in which all the rational arbitragers know that the asset is mis-priced and still are not willing to exploit it. I argue that investors have to coordinate and invest to push price back to the fundamental. I allow heterogeneous opportunity costs in the standard dynamic global games. Because of the information asymmetry about the opportunity cost of other investor, each investor invests less than the optimal. But over time, they learn about others' opportunity costs endogenously (through trading volume) and invest more which brings back the price to fundamental level. This leads to delayed arbitrage. Additional testable implications on the delay are also suggested.


Optimal Debt Maturity and Refinancing risk - A Dynamic model, with Jesse Davis (in progress)


 

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Naveen Reddy,
Apr 13, 2017, 5:36 AM
Ċ
Naveen Reddy,
Nov 19, 2017, 7:09 AM
Ċ
Naveen Reddy,
Nov 19, 2017, 7:17 AM
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