Credit Default Swaps in General Equilibrium: Endogenous Default and Credit-Spread Spillovers with Ehraz Refayet - Journal of Money, Credit, and Banking 50(8) 1901-1933.
Firms trade off investment scale with default costs and endogenously choose whether to issue large quantities of defaultable bonds or issue moderate amounts of safe debt. CDS affect this trade off. Covered CDS lower credit spreads and increase reliance of defaultable debt while naked CDS raise credit spreads and cause firms to issue safe debt. In general equilibrium, CDS markets affect all firm debt financing and investment choices, including non-CDS referenced debt.Half Full or Half Empty: Financial Institutions, CDS Trading, and Corporate Credit Risk with Cecilia Calgio and Eric Parolin - Journal of Financial Intermediation 40, 2019
Uses novel transaction-level data to match large U.S. bank CDS trades with corporate loan exposure. We provide new sets of facts relating CDS use with corporate credit risk: banks generally do not insure their loan positions, banks are more likely to sell CDS when they extend loans, and aggregate measures of CDS use overstate the extent to which banks hedge credit risk. Lastly, we show that empty creditor problems are not relevant for bank intermediaries.A Macroprudential Perspective on the Regulatory Boundaries of U.S. Financial Assets with Arseneau, Brang, Faber, Rappoport, and Vardoulakis. Journal of Financial Crises 5 (1), 1-26
This paper uses data from the Financial Accounts of the United States to map out the regulatory boundaries of assets held by U.S. financial institutions from a macroprudential perspective. We provide a quantitative measure of the regulatory perimeter—the boundary between the part of the financial sector that is subject to some form of prudential regulatory oversight and that which is not—and show how it has evolved over the past forty years. Additionally, we measure the boundaries between different regulatory agencies and financial institutions that operate within the regulatory perimeter and illustrate how these boundaries potentially become blurred in the face of regulatory overlap. Quantifying the regulatory perimeter and the boundaries for macroprudential regulators within the perimeter is informative for assessing financial stability risks over the credit cycle.A Model of Endogenous Debt Maturity with Heterogeneous Agents with Ehraz Refayet. Journal of Financial and Quantitative Analysis 60 (5), 2431-2468.
This paper studies how investor heterogeneity impacts equilibrium debt maturity. The optimal issuance strategy combines long- and short-term debts. A long-term debt contains default risk but hedges against intermediate downturns. A short-term debt provides repayment commitment but requires being rolled over and becomes risky during downturns. Issuing multiple debt maturities spreads the cost of these risky claims to investors most willing to hold risk at different points in time. The model predicts that debt maturity is more dispersed with lower financing costs and more investment opportunities when debt ownership is spread among many different types of investorsCollateral Heterogeneity and Monetary Policy Transmission: Evidence from Loans to SMEs and Large Firms with Cecilia Caglio and Sebnem Kalemli-Ozcan - (R&R Review of Economic Studies)
We study the role of heterogeneous financial frictions in the transmission of monetary policy, using firm-bank matched administrative data for the U.S. We find that collateral heterogeneity in loan contracts shapes both the pricing and the quantity of credit in response to monetary policy shocks. Small and risky (leveraged) firms pledge mostly accounts receivable, inventory, and blanket liens as collateral, tying their borrowing capacity to procyclical earnings. Loan spreads on these collateralized facilities respond less to monetary policy shocks than spreads on unsecured loans. At the same time, because the value of this collateral itself moves pro-cyclically, these firms' debt capacity expands during monetary easings and contracts during tightenings, so their borrowing and investment rise more during easings and fall more during tightenings than for other firms. Our micro estimates of this collateral-based debt-capacity channel are economically significant and can explain 77 percent of aggregate credit expansions and contractions.
Macroprudential Regulation and Lending Standards with Ehraz Refayet and Alexandros Vardoulakis - (Under Review)
We examine how macroprudential capital requirements interact with competition between banks and non-banks to shape lending standards. Banks have private information and benefit from deposit insurance, while non-banks lack such advantages but are less regulated. We show that higher capital requirements raise banks’ incentives to screen, tightening lending standards despite a decline in lender protections at the contract level. Non-bank competition does not erode but rather strengthens aggregate standards by crowding out riskier bank lending. Optimal capital regulation is lower in the presence of non-banks. Our analysis helps rationalize dynamics in leveraged loan and private credit markets.
Small Shocks and Exit Cascades: the Role of Non-Exclusive Competition and Outside Options with Jin-Wook Chang (Under Review)
When do small deteriorations in market quality trigger sudden, widespread collapses in trade? Existing results show that markets are robust to small shocks under exclusive contracting, while collapse is possible under knife-edge conditions in non-exclusive contracting with linear preferences. We ask when collapse is a general phenomenon. In the non-exclusive environment of Attar et al. (2021), we first show markets are generically robust: participation is governed by marginal conditions unaffected by another type’s exit, and active layers survive sufficiently small shocks. This robustness breaks down once outside options are generalized beyond autarky. We establish conditions for exit cascades: non-exclusive contracting, (partial) pooling, and outside options above the no-trade utility. A single exit then destroys the cheap shared layer that its presence provided to every remaining type, triggering a cascade that shuts down the entire market. The separating equilibria of Attar et al. (2014) are immune to such cascades even with generalized outside options due to the separation of contract pricing across types
QE, Bank Liquidity Risk Management, and Non-Bank Funding: Evidence from U.S. Administrative Data with Sotirios Kokas, Alexandros Kontonikas, Jose-Luis Peydro, and Alexandros Vardoulakis (In preperation)
We show that the effectiveness of unconventional monetary policy is limited by how banks adjust credit supply and manage liquidity risk in response to fragile non-bank funding. For identification, we use granular U.S. administrative data on deposit accounts and loan-level commitments, matched with bank-firm supervisory balance sheets. Quantitative easing increases bank fragility by triggering a large inflow of uninsured deposits from non-bank financial institutions. In response, banks that are more exposed to this fragility actively manage their liquidity risk by offering better rates to insured deposits, while cutting uninsured rates. Doing so, they shift away from uninsured to insured deposits. Importantly, on the asset side, these banks also reduce the supply of contingent credit lines to corporate clients. This tightening of liquidity provision has real effects, as firms reliant on more exposed banks experience a reduction in liquidity insurance stemming from credit lines, leading to lower investment. Our analysis reveals that the fragility of deposit funding can disrupt the complementarity between deposit-taking and the provision of credit lines.
General Adverse Selection Distortions with Jin-Wook Chang and Ehraz Refayet (In preparation)
We prove that the direction of equilibrium trade distortions under adverse selection is not determined by the information friction when uninformed types are heterogeneous. A general equilibrium price effect emerges links the terms of trade across informed types through market clearing: the quantity traded by one types shifts the marginal uninformed agent, altering the price faced by other types and changes the adverse selection cost. This interaction can reverse the canonical single-crossing result aka the Spence-Mirrlees condition. We establish a threshold theorem whereby when uninformed types are sufficiently similar, the constrained type distorts trade in the opposite direction to what single-crossing implies; when types are sufficiently dispersed, the standard result is restored. Classic results of Rothschild-Stiglitz underinsurance and Besanko-Thakor overinvestment are established as the homogeneous limit of the general theory.
This paper examines whether regulatory liquidity buffers enable banks to support corporate borrowers during financial stress. Using confidential bank-firm credit data and hand-collected Liquidity Coverage Ratio regulation (LCR) disclosures during COVID-19, we find that banks with higher LCR buffers above the regulatory minimum provided significantly more credit to firms with large undrawn credit lines in March 2020. Critically, only buffers, not overall LCR levels, matter, revealing that the regulatory minimum operates as a binding constraint during stress. The effect is concentrated among high-quality borrowers with clean credit profiles and disappears by mid-2020, confirming that LCR buffers provide selective, temporary liquidity insurance during acute stress
Private Firm Repayment Risk with Mary Zhang
This note examines repayment vulnerabilities among private borrowers in the U.S. under several economic scenarios. We compute interest coverage ratios (ICRs) using a supervisory data set covering the broadest cross-section of private firms in the U.S. We define repayment vulnerable firms as those with IRCs <1. The analysis considers a severely adverse scenario and a stagflation scenario. Private-firm balance sheets are generally strong position due to the prolonged low-interest rates and high earning growth. We find the IRCs fall and repayment vulnerabilities increase in both scenarios, but not to levels that generate systemic concern.
Banks vulnerable to runs may be affected both by deteriorating fundamentals and by pani-driven contagion. We investigate the fundamentals channel by asking whether banks' own regulatory disclosures contributed to deposit outflows ahead of the March 2023 collapse of Silicon Valley Bank (SVB). Using confidential deposit data, we identify 38 depository institutions that experienced anomalously large deposit outflows during the SVB episode. Using an event-study design, we then show that these vulnerable banks experienced a gradual drawdown in deposits following their 10-K filings and enarings calls in the weeks prior. Deposits bell 1.4% after 10-K released and 0.3% after earnings calls, concentrated in less sticky, more uninsured deposit categories; stable banks show no comparable response. These pre-collapse outflow were dwarfed by those during the SVB episode itself, suggesting that disclosure-driven withdrawals may precede, and later be amplified by, a subsequent panic-driven run.
The Real Effects of Financial Frictions and Monetary Policy Transmission: Micro-level Evidence with Cecilia Caglio, Thomas Drechsel, Sebnem Kalemli-Ozcan, and Veronkia Penciakova
Operating-Collateral Cycles (Preliminary)
We develop a model in which operating assets are simultaneously the collateral that supports a firm's current borrowing and the output of the activity that borrowing finances. A firm pledges inherited inventory and receivables to finance working capital, production, and sales; those activities generate the inventory and receivables that support next period's borrowing. A monetary tightening raises the effective cost of external finance, which lowers current borrowing and, because operating collateral is itself created by borrowing-financed activity, slows the creation of next period's collateral base. The result is a credit contraction that persists after the direct policy shock has passed, even holding fixed the pledgeability of each unit of collateral. The mechanism is strongest for firms that rely on operating rather than fixed collateral, and for firms whose collateral constraint binds. A companion empirical study of U.S. firm--bank loan contracts motivates the model: loans secured by accounts receivable, inventory, and blanket liens respond more strongly to monetary policy shocks, in both quantities and pricing, than loans secured by real estate and fixed assets, particularly among private firms and highly leveraged small and medium-sized enterprises. The model organizes these facts around a single dynamic mechanism and yields new, sharper predictions for the persistence of credit responses, the role of borrowing-base utilization, and the behavior of revolving asset-based credit facilities.
Non-exclusive Competitive Search with Adverse Selection with Jin-Wook Chang (Preliminary)
We study a directed-search (competitive search) environment with adverse selection and nonexclusive trading, in which privately informed sellers can multi-home across submarkets and trade with multiple buyers additively rather than choosing a single contract. We specialize to a two-submarket economy and derive equilibrium: the ex post allocation rule, interim payoffs, buyers' expected profits and free entry, and equilibrium conditions for single-homing (N=1) and two-market multi-homing (N=2). We prove existence of equilibrium, characterize type-dependent multi-homing patterns, establish conditions for equilibrium multiplicity, and analyze market shutdowns driven by compositional feedbacks across submarkets.