"Adverse Selection Dynamics in Privately-Produced Safe Debt Markets" AEJ:Macro (2024), Vol. 16 (1): pp. 441-468 [link][Online Appendix][Data and Code Repository][FEDS WP][NBER WP]
Privately-produced safe debt is designed so that there is no adverse selection in trade. But in some macro states, here the onset of the pandemic, it becomes profitable for some agents to produce private information, and then agents face adverse selection when they trade the debt (i.e., it becomes information-sensitive). We empirically study these adverse selection dynamics in a very important asset class, collateralized loan obligations (CLOs), which finance loans to below investment-grade firms. We decompose the bid-ask spreads on the AAA bonds of CLOs into a component reflecting dealer bank balance sheet costs and the adverse selection component.
"Self-fulfilling Runs: Evidence from the U.S. Life Insurance Industry" The Journal of Political Economy (2020), Vol. 128, No. 9, pp. 3520-3569. [link][Online Appendix][FEDS WP]
With B. Narajabad and S. Verani
Coverage: [Money and Banking][ThinkAdvisor]
Is liquidity creation in shadow banking vulnerable to self-fulfilling runs? Investors typically decide to withdraw simultaneously, making it challenging to identify self-fulfilling runs. In this paper, we exploit the contractual structure of funding agreement-backed securities offered by U.S. life insurers to institutional investors. The contracts allow us to obtain variation in investors’ expectations about other investors’ actions that is plausibly orthogonal to changes in fundamentals. We find that a run on U.S. life insurers during the summer of 2007 was partly due to self-fulfilling expectations. Our findings suggest that other contemporaneous runs in shadow banking by institutional investors may have had a self-fulfilling component.
"Over-the-Counter Market Liquidity and Securities Lending" Review of Economic Dynamics (2019), Vol. 33, pp. 272-294. [link][Online Appendix][FEDS WP][BIS WP]
With S. Gissler and S. Verani
Coverage: [Bloomberg][Brookings][Finadium][Market Insight (MLex)][Securities Lending Times][Moody's Analytics]
This paper studies how over-the-counter (OTC) market liquidity was adversely affected by the collapse of securities lending during the 2007-2008 financial crisis. We combine micro-data on corporate bond OTC market trades with securities lending transactions, in which insurance companies are major counterparties. We exploit cross-sectional differences in the corporate bonds held and lent by insurance companies to estimate the causal effect of securities lending on corporate bond market liquidity. We show that the run on insurers' securities lending programs in 2008 caused a long-lasting reduction in corporate bond market liquidity, even after controlling for the interaction between funding liquidity and market liquidity.
"The Impact of Unconventional Monetary Policy on Firm Financing Constraints: Evidence from the Maturity Extension Program" Journal of Financial Economics (2016), Vol. 122(2), pp. 409-429. [link][FEDS WP][Philly Fed WP]
With R. Ramcharan and E. Yu
Winner of the BankScope Prize for best banking paper at the 28th Australasian Finance and Banking Conference
This paper investigates the impact of unconventional monetary policy on firm financial constraints. It focuses on the Federal Reserve’s maturity extension program (MEP), intended to lower longer-term rates and flatten the yield curve by reducing the supply of long-term government debt. Consistent with those models that emphasize bond market segmentation and limits to arbitrage, around the MEP’s announcement, stock prices rose most sharply for those firms that are more dependent on longer-term debt. These firms also issued more long-term debt during the MEP and expanded employment and investment. These responses are most pronounced for those firms that are larger and older, and hence less likely to be financially constrained. There is also evidence of “reach for yield” behavior among some institutional investors, as the demand for riskier corporate debt also rose during the MEP. Our results suggest that unconventional monetary policy might have helped to relax financial constraints for some types of firms in part by inducing gap-filling behavior and affecting the pricing of risk in the bond market.
"Sovereign Debt Guarantees and Default: Lessons from the UK and Ireland, 1920-1938" European Economic Review (2016), Vol. 87, pp. 272-286. [link][final version]
With E. McLaughlin
Coverage: [The Economist][Financial Times][Finance Long Run][Positive Check][NEP-HIS]
We study the daily yields on Irish land bonds listed on the Dublin Stock Exchange during the years 1920-1938. We exploit Irish events during the period and structural differences in land bonds to tease out a measure of investors’ credibility in a UK sovereign guarantee. Using Ireland’s default on intergovernmental payments in 1932, we find a premium of about 43 basis points associated with uncertainty about the UK government guarantee. We discuss the economic and political forces behind the Irish and UK governments’ decisions pertaining to the default. Our finding has implications for modern-day proposals to issue jointly- guaranteed sovereign debt.
"Capitalising on the Irish Land Question: Land Reform and State Banking in Ireland: 1891-1938" Financial History Review (2016), Vol. 23(1), pp. 71-109. [link][final version]
With E. McLaughlin
Land reform and its financial arrangements are central elements of modern Irish history. Yet to date, the financial mechanisms underpinning Irish land reform have been overlooked. The paper outlines the mechanisms of land reform in Ireland and the importance of land bonds to the process. Advances worth over £127 million were made to tenant farmers to purchase their holdings. These schemes enabled the transfer of over three quarters of land on the island of Ireland. The paper introduces a new database on Irish land bonds listed on the Dublin Stock Exchange from 1891 to 1938. It illustrates the nature of these bonds and presents data on their size, liquidity and market returns. The paper finds a high level of state banking in Ireland: large issues of land bonds were held by state-owned savings banks.
"US Real Interest Rates and Default Risk in Emerging Economies" Journal of Money, Credit and Banking (2013), Vol. 45(5), pp. 967-975. [link][final version][IFDP]
With B. Guimaraes
We empirically analyse the appropriateness of indexing emerging market sovereign debt to US real interest rates. We find that policy-induced exogenous increases in US rates raise default risk in emerging market economies, as hypothesised in the theoretical literature. However, we also find evidence that omitted variables which simultaneously increase US real interest rates and reduce the risk of default dominate the hypothesised relationship. We can only conclude that it's not a good idea to index emerging market bonds to US real interest rates.
"Information Networks over the Business Cycle" [June 2025]
We calculate a sectoral-level information flow matrix, quarterly, using a structural model of firm managers learning from stock prices. We then calculate network informativeness, measuring how easily information flows across sectors. We study relationships over the business cycle between network informativeness and other macroeconomic variables. We find that network informativeness is a leading indicator of real business cycles. In time-series analysis, information flowing more easily occurs before stronger industrial production and real GDP. These dynamics reverse when information flow becomes more restricted. We link network informativeness to information production by stock analysts. Our measure correlates with the analyst recommendation cycle lagged by several quarters.
"Funds of funds' Portfolio Rebalancing during the Covid-19 Crisis" [April 2025]
With Jeongmin "Mina" Lee
During the COVID-19 crisis, bond mutual funds experienced significant outflows that disrupted debt markets. We show that "funds of funds"-mutual funds that invest in other mutual funds-played a surprisingly large role in this episode. Despite experiencing minimal redemptions themselves, funds of funds rebalanced their portfolios mechanically in response to equity market losses, selling approximately $70-80 billion of bond funds and purchasing equity funds. This behavior accounted for 25-30 percent of all bond fund outflows in March 2020. Our findings highlight how portfolio rebalancing by institutional investors can transmit shocks across markets and amplify financial fragility.
"Measuring Interest Rate Risk Management by Financial Institutions" [September 2024][Poster][FEDS WP]
With C. Brunetti and S. Verani
Revise and resubmit at the Review of Asset Pricing Studies
Winner of the Best Conference Paper at the 16th International Risk Management Conference (2023)
Coverage: [FSOC Annual Report]
Financial intermediaries manage myriad interest rate risk exposures. We propose a new method to measure financial intermediaries' residual interest rate risk using high-frequency financial market data. Our method exploits all available high-frequency information and is valid under extremely weak assumptions. Applying the method to U.S. life insurers, we find their interest rate risk management strategies are generally effective. However, life insurers are more sensitive to changes in long-term interest rates than property and casualty insurers. We show that the term premium helps to explain the difference in sensitivities between the two types of insurer.
"The Informational Centrality of Banks" [December 2023][FEDS WP][NBER WP]
The equity and debt prices of large nonbank firms contain information about the future state of the banking system. In this sense, banks are informationally central. The amount of this information varies over time and over equity and debt. During a financial crisis banks are, by definition of a crisis, at risk of failure. Debt prices became about 50 percent more informative than equity prices about the future state of the banking system during the financial crisis of 2007-2009. This was partly due to investors' fears that banks might not be able to refinance their debt.
"Are US Life Insurers the New Shadow Banks?" [April 2023]
With N. Heinrich and S. Verani
Content also appears as "US Life Insurers and Systemic Risk" in the Research Handbook of Macroprudential Policy [September 2024]
Coverage: [NYTimes][News Items][NBC][ThinkAdvisor][IAR][MarketWatch]
This paper studies the restructuring of financial intermediation in the United States since the 2007-09 financial crisis. We show that the largest U.S. life insurers have entered private debt markets as banks refocused on commercial banking, against a backdrop of unconventional monetary policies and tighter bank regulations. Through complex on- and off-balance sheet arrangements, these insurers, many of whom are controlled by private equity firms, are acquiring and deploying vast amounts of annuity capital to capture the illiquidity premium. The new architecture of the financial system features novel forms of lending. That said, life insurers have become more vulnerable to an aggregate shock to the corporate sector.
"Who Limits Arbitrage?" [March 2019] preliminary and incomplete
With B. Narajabad and S. Verani
This paper proposes and tests a theory of endogenous limits of arbitrage. We incorporate short-sale restrictions and an imperfectly competitive securities lending market into a model of securities traders with private information. The cost of short selling a security is an equilibrium outcome of the demand for short positions and the willingness of buy-and-hold institutional investors to supply their securities to short sellers. Securities lenders with greater risk tolerance are more willing to lend their securities, lowering the cost of taking short positions, which increases price informativeness in the spot trading market. We provide compelling evidence that the corporate bonds held by more risk tolerant insurance companies with securities lending programs tend to have greater spot market trade volume and more price informativeness. Controlling for each individual bond's demand, we identify the mechanism proposed by the model. Insurance companies with more risky cash collateral reinvestment portfolios are more willing to lend corporate bonds that are otherwise costly for short sellers to borrow. Our results suggest a new connection between liability-driven investment and asset pricing.
"Securities Lending as Wholesale Funding: Evidence from the US Life Insurance Industry" [December 2019][NBER WP]
With B. Narajabad and S. Verani
Coverage: [NBER][Money and Banking]
The securities lending market for corporate bonds relies on the willingness of institutional investors to lend their bond holdings. Life insurers are major suppliers of bonds in the securities lending market. By lending their bonds against cash collateral, insurers create short-term liabilities that are prone to runs. We show that, controlling for bond borrowers' demand, the maturity of an insurer's cash collateral reinvestment portfolio determines its decision to lend individual bonds. Insurers' cash collateral reinvestment strategy, as part of their interest rate risk management, drives supply in the securities lending market. Our results suggest a new source of financial fragility.
"The Timing of Default Over Electoral Terms" [IFDP]
This paper studies the timing of default decisions during and over the terms of elected politicians, as an empirical investigation of the postulated theory in the sovereign debt literature that the political costs of sovereign default are a reason why sovereign debt may be repaid. I find no robust patterns in the timing of default decisions over terms of office. There is some tentative evidence that elected leaders that default are also those more likely to be re-elected. Using a simple career concerns model of political leadership, I demonstrate how both of these features can emerge when politicians care about re-election.
"Life Insurers’ Role in the Intermediation Chain of Public and Private Credit to Risky Firms" FEDS Notes. Washington: Board of Governors of the Federal Reserve System, March 21, 2025.
With S. Carlino, N. Heinrich, and S. Verani
Coverage: [Central Banking][Life Risk News][RIJ]
This note quantifies life insurers' role in the intermediation of public and private credit to risky firms. Since the 2007-09 financial crisis, the share of life insurers' general account assets exposed to below-investment-grade ('risky') corporate debt has roughly doubled. Life insurers invest directly in risky firms through high-yield corporate bonds and leveraged loans, while also gaining exposure indirectly via broadly syndicated loan (BSL) collateralized loan obligations (CLOs), middle market (MM) CLOs, business development companies (BDCs), and joint venture loan funds (JVLFs). Life insurers' affiliated asset managers have become major corporate loan originators and managers of BSL and MM CLOs, BDCs, and JVLFs. Partnerships between life insurers and asset managers have created complex and arguably opaque structures to increase investment returns. These arrangements seek to shift portfolio allocations towards risky corporate debt while exploiting loopholes stemming from rating agency methodologies and accounting standards.
"How Do U.S. Life Insurers Manage Liquidity in Times of Stress" FEDS Notes. Washington: Board of Governors of the Federal Reserve System, August 23, 2022.
With N. Heinrich and S. Verani
Coverage: [FT]
In this note, we describe U.S. life insurers' liquidity management when the COVID-19 pandemic broke. We show that life insurance companies immediately created cash buffers to manage potential liquidity shocks. They did not create these buffers by selling their liquid assets. Rather, life insurers' cash buffers came largely from Federal Home Loan Banks (FHLBs) and interest rate derivatives. Understanding the sources of liquidity in times of crises is crucial, as the National Association of Insurance Commissioners (NAIC) continues its review and development of new guidance for regulation of life insurers' liquidity management.
"Assessing the Size of the Risks Posed by Life Insurers' Nontraditional Liabilities" FEDS Notes. Washington: Board of Governors of the Federal Reserve System, May 21, 2019.
With B. Narajabad and S. Verani
Coverage: [Think Advisor]
This note discusses potential methods for assessing the size of the run risk associated with life insurers' nontraditional liabilities. A run on a life insurer poses a potential financial stability risk if the life insurer plays an important role in the financial system. For example, during the financial crisis of 2007-09, runs occurred on several types of nontraditional liabilities issued by life insurers. Some of the largest and most interconnected life insurers that experienced runs required substantial government assistance to prevent spillovers to households and to the rest of the financial system.
"Funding Agreement-Backed Securities in the Enhanced Financial Accounts" FEDS Notes. Washington: Board of Governors of the Federal Reserve System, August 5, 2016.
With R. Meisenzahl, B. Narajabad, M. Perozek, and S. Verani
This note describes new data on funding agreement-backed securities (FABS) that is being provided as part of the Enhanced Financial Accounts (EFA) initiative. This EFA project expands upon the Financial Accounts data by providing daily data for different types of FABS that vary by maturity at issue and embedded optionality. The more granular data presented in this EFA project provides a clearer picture of developments in this important funding market, including the run on a segment of the FABS market starting in the summer of 2007.
"International Portfolio Frictions" by W. Du, A. Fontana, P. Jakubik, R. Koijen, and H. Shin [IMF AMFR 2025 discussion slides]
"LASH Risk and Interest Rates" by L. Alfaro, S. Bahaj, R. Czech, J. Hazell, and I. Neamtu [NBER 2024 discussion slides]
"Investing in Safety" by J. Breckenfelder, V. De Falco, and M. Hoerova [BSE 2024 discussion slides]
"Wholesale Funding Runs, Spreads, and Central Bank Interventions" by J. Magnani and Y. Wang [YPFS 2023 discussion slides][paper link]
"Dynamic Equilibrium with Costly Short-Selling and Lending Market" by A. Atmaz, S. Basak, and F. Ruan [EFA 2021 discussion slides][paper link]
"Worried Depositors" by M. Chavaz and P. Slutzky [Day Ahead Conference 2020 discussion slides][paper link]
"Insurers as Asset Managers and Systemic Risk" by A. Ellul, C. Jotikasthira, A. Kartasheva, C. Lundblad, and W. Wagner [FIRS discussion slides][paper link]
"The Bond Pricing Implications of Rating-Based Capital Requirements" by S. Murray and S. Nikolova [CFIC discussion slides][paper link]
"Price and Volume Dynamics in Bubbles" by J. Liao and C. Peng [EWFC discussion slides][paper link]