Stéphane Verani

I am a Principal Economist in the Systemic Financial Institutions and Markets section of the Federal Reserve Board, and this is my personal research page. Follow this link to access my official FRB page and contact information. The views expressed on this site are mine and do not necessarily reflect the views of the Board of Governors of the Federal Reserve System or its staff. I am a member of the Macro Finance Society. [CV] [Google scholar] [SSRN] [RePEc]


[current research]


13. The Informational Centrality of Banks (with Nathan Foley-Fisher and Gary Gorton) [NBER WP#32007] [this version: January 2024] 


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 due to firms' fears that banks might not be able to rollover their debt.  


12. Measuring Interest Rate Risk Management by Financial Institutions (with Celso Brunetti and Nathan Foley-Fisher) [PDF] [this version: October 2023] 


Financial intermediaries manage myriad interest rate risk exposures. We propose a new method to measure financial intermediaries' residual interest rate risk using a two-factor model and 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 explains the difference in sensitivities between the two types of insurers.  


11. Optimal Retirement Policies with Private Annuities (with Pei Cheng Yu) [draft on request] [this version: June 2024] 

We study optimal retirement policies in a life-cycle model where individuals privately learn about their productivity, longevity, and altruism. Beyond adverse selection, decentralization frictions stem from the cost of managing interest rate risk associated with life annuity sales. Using standard dynamic mechanism design techniques, we show that the government uses social security for post-retirement redistribution and annuities and savings to screen for longevity and altruism. The government addresses private annuity market frictions by selecting a debt maturity that balances interest rate risk and market inefficiencies.


10. Who Limits Arbitrage? (with Nathan Foley-Fisher and Borghan Narajabad) [PDF] [this version: April, 2021] 


Limits of arbitrage prevent prices from fully revealing securities' fundamental value. We show that risk taking in the securities lending market, which operates in tandem with the spot market, plays an important role in shaping the limits of arbitrage. Securities lenders taking greater risk with their cash collateral reinvestment decrease short-selling costs and increase price informativeness in the securities spot market. We identify this causal relationship in a data set matching corporate bond loans and trades to securities lenders' cash collateral reinvestment. The effect of risk taking by securities lenders is large, narrowing the bid-ask spread by around ten basis points.



9. Are US Life Insurers the New Shadow Banks? (with Nathan Foley-Fisher and Nathan Heinrich) [PDF] [this version: April, 2023] [This is an updated version of the paper Capturing the Illiquidity Premium that was circulated from February 2020] 

We show that the largest U.S. life insurers entered corporate loan markets as banks refocused on commercial banking from 2009, 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 insurance liabilities to fill the void left by banks. Using the COVID-19 pandemic, we show that life insurers have become more vulnerable to an aggregate shock to the corporate sector and disproportionately benefited from the Fed's response to the pandemic.


8. Securities Lending as Wholesale Funding: Evidence from the U.S. Life Insurance Industry (with Nathan Foley-Fisher and Borghan Narajabad) [PDF] [this version: December, 2019] [NBER WP#22774 ]


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.


7. Financing Constraints, Firm Dynamics, and International Trade (with Till Gross) [PDF] [online appendix] [this version: November, 2013]


This paper studies the impact of financial constraints on exporter dynamics, and the role of financial intermediation in international trade. We propose a two-country general equilibrium model economy in which entrepreneurs and lenders engage in long-term credit relationships. Financial markets are endogenously incomplete because of private information, and .financial constraints arise as a consequence of optimal financial contracts. Young and small firms operate below their efficient level, and their financial constraint is relaxed as the entrepreneur's claim to future cash-flows increases. Consistent with empirical regularities, there is a substantial year-to-year transition in and out of export markets for smaller firms, and new exporters account only for a small share of total exports. Established exporters are less likely to exit export markets and tend to experience slower, albeit more stable growth.



[published / forthcoming / accepted articles]



6. What's Wrong with Annuity Markets? (with Pei Cheng Yu) [PDF] [this version: October, 2023] Accepted by the Journal of the European Economic Association


We show that the supply of life annuities in the U.S. is constrained by interest rate risk. We identify this effect using annuity prices offered by U.S. life insurers from 1989 to 2019 and exogenous variations in contract-level regulatory capital requirements. The cost of interest rate risk management accounts for at least half of the average life annuity markups or eight percentage points. The contribution of interest rate risk to annuity markups sharply increased after the great financial crisis, suggesting new retirees' opportunities to transfer their longevity risk are unlikely to improve in a persistently low interest rate environment.


5. Adverse Selection Dynamics in Privately-Produced Safe Debt Markets (with Nathan Foley-Fisher and Gary Gorton) [American Economic Journal: Macroeconomics, 2024, 16 (1): 441-68]


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.  


4. Self-fulfilling Runs: Evidence from the U.S. Life Insurance Industry (with Nathan Foley-Fisher and Borghan Narajabad) [model slides] [Journal of Political Economy, 2020, 128:3520-3569]


The interaction of worsening fundamentals and strategic complementarities among investors renders identification of self-fulfilling runs challenging. We propose a dynamic model to show how exogenous variation in firms' liability structures can be exploited to obtain variation in the strength of strategic complementarities. Applying this identification strategy to puttable securities offered by U.S. life insurers, we find that at least 40 percent of the $18 billion run on life insurers by institutional investors during the 2007-08 crisis was amplified by self-fulfilling expectations. Our findings suggest that other contemporaneous runs in shadow banking by institutional investors may have had a self-fulfilling component.


3. Over-the-Counter Market Liquidity and Securities Lending (with Nathan Foley-Fisher and Stefan Gissler) [Review of Economic Dynamics, 2019, 33:272-294]


This paper studies how over-the-counter market liquidity is affected by securities lending. We combine micro-data on corporate bond market trades with securities lending transactions and individual corporate bond holdings by U.S. insurance companies. Applying a difference-in-differences empirical strategy, we show that the shutdown of AIG's securities lending program in 2008 caused a statistically and economically significant reduction in the market liquidity of corporate bonds predominantly held by AIG. We also show that an important mechanism behind the decrease in corporate bond liquidity was a shift towards relatively small trades among a greater number of dealers in the interdealer market.



2. Aggregate Consequences of Dynamic Credit Relationships [online appendix] [Review of Economic Dynamics, 2018, 29:44–67]


I investigate the aggregate consequences of canonical financial frictions in the supply of credit to firms: private information and limited enforcement. I propose a general equilibrium model in which entrepreneurs finance their firm through a long-term contract with a financial intermediary. The contract is inefficient because firm cash flow is costly to monitor, and borrowers that repudiate cannot be excluded from capital markets. By investing in enforcement capacity, an intermediary can delay debt repayment and maintain incentive compatibility. Reforms that seek to decrease either the cost of monitoring or enforcing contracts, or both, affect firm dynamics and can generate complementarities. Estimating the model with data on Colombian manufacturing firms in the 1980s and 1990s, I find that financial frictions are responsible for a significant aggregate output loss. Most of this distortion can be attributed to private information. Reforms that only reduce private information create significant economic growth and welfare gains, while those that only improve enforcement do not. There are significant complementaritities between different types of reforms, as moral hazard is less significant when contracts are more enforceable.



1. From Wall Street to Main Street: The Impact of the Financial Crisis on Consumer Credit Supply (with Rodney Ramcharan and Skander Van Den Heuvel) [Journal of Finance, 2016, 71:1323–1356]


How did the collapse of the asset-backed securities (ABS) market during the 2007 to 2009 financial crisis affect the supply of credit to the broader economy? Using new data on the U.S. credit union industry, we find that ABS-related losses are associated with a large contraction in the supply of credit to consumers, especially among those credit unions that began the crisis with weaker capitalization. We also find that this credit supply shock restricted the availability of mortgage and automobile credit. These results show how movements in the prices of financial assets can affect the real economy.




[federal reserve board publications]


Foley-Fisher, Nathan, Nathan Heinrich, and Stephane Verani (2022). "How Do Life Insurers Manage Liquidity in Times of Stress?," FEDS Notes. Washington: Board of Governors of the Federal Reserve System, August 23, 2022

This note describes 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.


Foley-Fisher, Nathan, Borghan Narajabad, and Stephane Verani (2019). "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


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.




Foley-Fisher, Nathan, Ralf Meisenzahl, Borghan Narajabad, Maria Perozek, and Stephane Verani (2016). "Funding Agreement-Backed Securities in the Enhanced Financial Accounts," FEDS Notes. Washington: Board of Governors of the Federal Reserve System, August 5, 2016


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.





[discussions]