Valentin Haddad

This paper provides a guide for using causal inference with asset prices and quantities. Our framework revolves around an elementary assumption about portfolio demand: homogeneous substitution conditional on observables. Under this assumption, standard cross-sectional instrumental variables or difference-in-difference regressions identify the relative demand elasticity between assets with the same observables, the difference between own-price and cross-price elasticity. In contrast, identifying aggregate elasticities and substitution along specific characteristics requires joint estimation using multiple sources of exogenous time-series variation. The same principles apply to the estimation of multipliers measuring the price impact of supply or demand shocks. Our assumption maps to familiar restrictions on covariance matrices in classical asset pricing models, encompass demand models such as logit, and accommodate rich substitution patterns even outside of these models. We discuss how to design experiments satisfying this condition and offer diagnostics to validate it.

Asset Purchase Rules: How Quantitative Easing Transformed the Bond Market (with Alan Moreira and Tyler Muir)

We argue that quantitative easing (QE) and tightening policies constitute a dynamic state-contingent plan instead of a succession of independent interventions. This view changes the main reason QE is effective by adding an insurance channel to the static effect of absorbing bond supply in a given period. QE purchases occur in bad economic states (e.g., 2008-2009 or 2020) when the supply of government debt increases. Increasing long-term bond prices in bad economic states increases their safety, driving up their value and thus lowering ex-ante yields. We estimate that this insurance channel alone lowers long-term bond yields by 75-100 bps. This channel explains the prevalence of low long-term yields, low term premia, and low yield volatility since the introduction of QE, despite the sharp increase in net government debt supply. Consistent with a state-contingent channel, implied volatilities of long-duration risk-free securities fall substantially on QE announcements, even for options with maturities out to 10 years. We calibrate a policy rule for asset purchases to their historical path and include it in a quantitative term structure model. In the model, state-contingent QE offsets term premia fluctuations in long-term bonds. The insurance effect from this channel lowers long-term Treasury yields by 75bps ex-ante, which explains about 75% of the total effect of QE on yields. The calibrated model matches both broad patterns in bond yields and the response to QE announcements.

What do Financial Markets Say About the Exchange Rate?

(with Mikhail Chernov and Oleg Itskhoki)

Revise and Resubmit

Financial markets play two roles with implications for the exchange rate: they accommodate risk sharing and act as a source of shocks. In prevailing theories, these roles are seen as mutually exclusive and individually face challenges in explaining exchange rate dynamics. However, we demonstrate that this is not necessarily the case. We develop an analytical framework that characterizes the link between exchange rates and finance across all conceivable market structures. Our findings indicate that full market segmentation is not necessary for financial shocks to explain exchange rates. Moreover, financial markets can accommodate a significant extent of international risk sharing without leading to the traditional puzzles associated with the macro-finance exchange rate disconnect. We identify plausible market structures where both roles coexist, addressing challenges faced when examined separately.

Bank Fragility when Depositors are the Asset

(with Barney Hartman-Glaser and Tyler Muir)

Banks' relationships with their depositors are valuable when depositors remain sticky, but this value evaporates if they leave. This tension makes banks fragile when interest rates increase and long-term asset values are depressed. In this scenario, if all of its depositors leave, the bank fails, which justifies depositors' departure in the first place. Such failures can happen even when banks only invest in liquid assets and when deposits are insured, and they are more likely for banks with the most valuable relationships. This fragility leads to sharp changes in the exposure of bank values to interest rate risk: insensitive most of the time but highly responsive when asset losses are about to catch up with them. This non-linearity complicates the evaluation of capital adequacy, with neither mark-to-market nor hold-to-maturity providing an accurate picture of bank health. We find evidence consistent with these mechanisms during the rate increase of 2022 and 2023, culminating with the failure of Silicon Valley Bank.

The Federal Reserve and Market Confidence

(with Nina Boyarchenko and Matthew Plosser)

Slides

We discover a novel monetary policy shock that has a widespread impact on aggregate financial conditions and market confidence. Our shock can be summarized by the response of long-horizon yields to FOMC announcements; not only is it orthogonal to changes in the near-term path of policy rates, but it also explains more than half of the abnormal variation in the yield curve on announcement days. We find that our shock is positively related to changes in real interest rates and market volatility, and negatively related to market returns and mortgage issuance, consistent with policy announcements affecting market confidence. Our results demonstrate that Federal Reserve pronouncements influence markets independent of changes in the stance of conventional monetary policy.

Concentrated Ownership and Equilibrium Asset Prices

Investors can choose to hold diversified or levered, concentrated portfolios of risky assets. This paper studies the dynamics of asset prices in an economy in which both investment styles coexist in equilibrium even though all agents are ex-ante identical. I capture the tradeoff between risk sharing and productivity gains by introducing what I call “active capital.” People who participate in such investments are restricted in their outside opportunities but receive extra compensation for the productivity gains they bring to the corresponding enterprises. I show that fluctuations in the quantity of active capital increase the volatility of asset prices relative to a standard economy. Not all shocks shift the distribution of ownership: risk considerations determine the willingness to provide active capital, whereas current and expected future economic activity do not play a role. Therefore, active capital fluctuates jointly with risk premia, amplifying their variations. As a consequence, the price of volatility risk exposure can be large, and return volatility is mainly induced by fluctuations in future expected returns. These results are particularly strong when fundamental volatility is low, because at such times, a large number of concentrated owners are likely to exit their positions and sell off their assets.

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