Research

Publications

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. Forthcoming Journal of Financial Crises

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.

Working Papers

A Model of Endogenous Debt Maturity with Heterogeneous Agents with Ehraz Refayet (R&R - Journal of Financial and Quantitative Analysis)

In a model with repayment enforcement frictions and defaultable debt, we show that firms are indifferent to either issuing all long- or short-term debt, but never a combination of the two in partial equilibrium and representative lender economies. This is at odds with empirical evidence because firms generally issue combinations of debt maturities. We reconcile this using a general equilibrium model with heterogeneous lenders. Firms use debt maturity to cater claims to investors demand for assets across time. Hence, maturity mismatch and debt dilution can actually increase investment and firm value. Lastly, negative pledge covenants in long-term debt contracts simply act as substitutes for short-term debt and do not affect real decisions when risky debt prices are endogenous.

Collateral Heterogeneity and Monetary Policy Transmission: Evidence from Loans to SMEs and Large Firms with Cecilia Caglio and Sebnem Kalemli-Ozcan - (Under Review)

Using matched firm-bank level administrative data for the U.S., we document new facts on heterogeneity in firms' financing conditions and quantify its effects on monetary policy transmission. Most private firms in the U.S. are small-medium-size-enterprises (SMEs), whose entire balance sheet debt comes from banks and is collateralized mostly with earnings and intangibles, i.e., their enterprise value. Highly leveraged SMEs' respond to monetary expansions more by increasing their credit demand. They borrow more at lower spreads by pledging earnings-based collateral, whose value increases with monetary expansions. Our results link the bank lending and firm investment channels of monetary policy and show that the impact of policy on investment is stronger in an environment with a large number of small firms, whose borrowing depends on earnings-based constraints.

Mixed Signals: Investment Distortions with Asymmetric Information with Ehraz Refayet (Updated Draft Coming Soon)

We show that pecuniary externalities interact with information asymmetries and can generate trade distortions either above or below perfect information allocations through general equilibrium effects. The pecuniary externality is not present in partial equilibrium and representative investor economies. Consequently, allocations are always determined by the Spence-Mirrlees single crossing condition in which high types are always more willing to trade than low types and allocations are distorted above the perfect information allocations. In general equilibrium, the degree of heterogeneity between informed agents determines whether allocations are distorted above or below perfect information levels.

Banks, Non-banks, and Lending Standards with Ehraz Refayet and Alexandros Vardoulakis - (Updated Draft Coming Soon)

We study how competition between banks and non-banks affects lending standards. Banks have private information about some borrowers and are subject to capital requirements to mitigate risk-taking incentives from deposit insurance. Non-banks are uninformed and market forces determine their capital structure. We show that lending standards monotonically increase in bank capital requirements. Intuitively, higher capital requirements raise banks' skin in the game and screening out bad projects assures positive expected lending returns. Non-banks enter the market when capital requirements are sufficiently high, but do not cause a deterioration in lending standards. Optimal capital requirements trade-off inefficient lending to bad projects under loose standards with inefficient collateral liquidation under tight standards

Moldy Lemons and Market Shutdowns with Jin-Wook Chang

This paper studies conditions under which small changes in fundamentals cause competitive markets to shutdown due to adverse selection ala Akerlof, but sellers post nonexclusive menus of contracts. We first show that markets with non-exclusive competition are generally robust to small changes in the risk profile of agents (moldy lemons). Next, we show that a small change in the risk profile of agents can lead to a cascade of exits and market shutdowns in the presence of outside options. Finally, we show that more precise information about agents' types makes markets more prone to exit cascades. The model is general, does not rely on institutional details or structure, and thus applicable to many different markets and contexts.

Short Papers

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 severly 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.


Work In Progress

The Real Effects of Financial Frictions and Monetary Policy Transmission: Micro-level Evidence with Cecilia Caglio, Thomas Drechsel, Sebnem Kalemli-Ozcan, and Veronkia Penciakova

Macroprudential and Unconventional Monetary Policy Spillovers with Sotirios Kokas, Alexandros Kontonikas, Jose-Luis Peydro, and Alexandros Vardoulakis

Why do Firms go Public with Cecilia Caglio, Sebnem Kalemli-Ozcan and Jeremy Stein

How do Banks use Private Information? with Cecila Caglio and Tugkan Tuzun