Revise and Resubmit, European Economic Review
This paper proposes the outside option channel of central bank asset purchase programs. After the global financial crisis, central banks have engaged in purchasing assets traded in over-thecounter (OTC) secondary markets with substantial matching frictions and bargaining features. In this context, an asset purchase announcement improves the seller’s outside option in bargaining, thereby increasing asset prices even without actual purchases. I develop a theoretical model to illustrate the mechanics of this outside option channel, which helps explain why the Federal Reserve purchased more than $1 trillion of agency MBS during the global financial crisis but only $14 billion of corporate bonds during the COVID crisis despite stabilizing both markets. The model also shows that asset purchases and liquidity provision policies target different margins in OTC markets: asset purchases improve sellers’ outside options, whereas liquidity provision relaxes buyers’ funding constraints.
With Noh-Sun Kwark
Economic Modelling, 94 (2021), 351–369
Published version — Journal website | Working paper version — PDF (October 2020)
With growing interest in the effects of financial conditions on the real economy after the global financial crisis, this study constructs a Korean financial conditions index and examines the effects of the Korean and the US financial conditions on future Korean GDP growth using quantile regression models. We find that the impact of Korean financial conditions on the future GDP growth of Korea is asymmetric in quantiles. The deterioration of financial conditions expands only the left tail of the distribution of next quarter’s GDP growth and sometimes makes the distribution bimodal, implying the existence of multiple equilibria of bank runs and no bank runs distributions. The extended quantile regression model with US variables shows that the deterioration of US financial conditions expands both of the left and right tails of the distribution of the Korean GDP growth, increasing its variance.
2021 Korean Economy Academic Research Award, Korean Economic Association
I develop a search-theoretic model of corporate bond crisis dynamics with a finite dealer inventory ceiling and frictional interdealer trading. The model distinguishes disturbances dominated by more investors wishing to sell from those dominated by a higher cost of holding bonds. With stationary parameters calibrated to U.S. trading and inventory moments, the two shocks generate nearly identical price paths but different trading volumes, spreads, and inventory pressures. In the calibration, faster matching improves stationary liquidity and attenuates the holding-cost shock, yet amplifies the selling-pressure response when absorption capacity is scarce. The inventory ceiling allows dealer regulation to affect both carrying costs and maximum intermediation capacity. Lower capacity barely changes normal-time spreads yet substantially amplifies crisis price declines; higher dealer holding costs raise normal-time spreads more directly. Anticipated central-bank purchases support prices under both shocks. Small programs produce larger effects under the holding-cost shock, but this relative advantage narrows as purchases expand and private trading flows adjust. The results show that similar observed price dislocations can conceal different sources of distress and therefore different responses to market design, dealer regulation, and asset-purchase policy.
With Athanasios Geromichalos, Kuk Mo Jung, Ioannis Kospentaris, and Sukjoon Lee
Central banks around the world routinely engage in asset purchases in secondary markets as part of implementing monetary policy or enhancing market liquidity, but the effects of such interventions are not yet fully understood. We develop a multi-asset general equilibrium model in which the liquidity of an asset is endogenous and depends on the terms of trade in each asset’s respective secondary market, which are, in turn, driven by agents’ market entry decisions and the possibility of central bank intervention. We use our model to qualitatively and quantitatively rationalize the superior liquidity of U.S. Treasuries over corporate bonds of comparable safety. Our model highlights and quantifies an unexplored link between fiscal and monetary policy: central bank interventions in the market for Treasuries increase secondary market liquidity for these securities, thus indirectly aiding the Treasury to borrow at lower rates. Our results also reveal that central bank interventions can have spillover effects on markets where the bank does not participate, offering a cautionary note to both policymakers and empirical researchers.
With Athanasios Geromichalos, Lucas Herrenbrueck, and Sukjoon Lee
We build on recent developments in the theory of money and liquidity to provide a qualitative and quantitative explanation for the well-known TIPS illiquidity vis-a-vis non- ` inflation-protected Treasuries. Our model does not assume exogenous differences between the markets where the two assets are traded or the investors who hold them; instead, an asset’s liquidity is endogenous and depends on the trading and market entry decisions of investors. The model offers a powerful amplification mechanism that operates upon only one difference between TIPS and Treasuries: the far greater supply of the latter. We provide suggestive time-series evidence consistent with this mechanism. We also quantify how much the Treasury leaves on the table by issuing securities that are not as highly valued by the market as nominal Treasuries, thus informing the recent debate. The model does not necessarily imply that the Treasury should phase out TIPS, as some have suggested, only that it should seek to reduce segmentation and ensure that TIPS trade alongside nominal Treasuries in consolidated secondary markets.
With Athanasios Geromichalos, Lucas Herrenbrueck, Sukjoon Lee, and Zijian Wang