"Over-Collateralization against too many Lenders" [link]
Abstract:
Archegos Capital collapsed in 2021 following the build-up of high leverage from multiple lenders. Although lending was secured, the lenders experienced large losses since they all held similar stocks as collateral, unbeknownst to each other, which they ended up selling at fire-sale prices. To understand the role of collateral in the presence of multiple lenders, I develop a model in which the collateral value is endogenous. The model provides a new perspective on the role of over-collateralized loans: By encumbering assets, they expose excessive lending from additional lenders to direct dilution. The results suggest that transparency, often viewed as a panacea in the policy debate, can backfire by reducing the threat of dilution to additional lenders. The model generates the empirical prediction that minimum collateral requirements can increase efficient lending. Applied to mortgage markets, this prediction rationalizes higher loan-to-value requirements for speculative additional mortgages relative to first-time buyers.
Further work in progress:
"Adverse Selection in Non-Treasury Repos" [link]
Abstract:
I study theoretically and empirically how the presence of informed and uninformed participants affects rates of non-treasury repurchase agreements (repos). I find that in the event of an uncertainty shock about collateral values (i.e., VIX spike), the interest rates charged by uninformed cash-lenders, money market funds, increases more for cash-borrowers with many connections to sophisticated institutions (i.e., proxied by hedge fund connections in ADV data). Consistent with the model prediction, this effect only materializes for repo collateral that is prone to information asymmetries, such as risky corporate bonds or equities, but not for safe corporate bonds.
"Dynamic Liquidity Provision under Capital Constraints" [link]
Abstract:
After the financial crisis, corporate bond practitioners lamented a poor state of market liquidity for large corporate bond trades, while academic research painted an inconclusive picture of liquidity conditions. Motivated by this tension, I find theoretically that scarce capital, together with market incompleteness, can delay trades. The market incompleteness stems from restrictive investment mandates that prohibit agents from trading derivative contracts, in particular forward contracts. Due to the absence of forward contracts, the agents must trade bundles of state-contingent claims. When the buyer's capital is scarce, the buyer wants to minimize capital used on the purchase of claims without gains from trade. Waiting unbundles claims, allowing for more productive use of capital. Therefore, I argue that scarce capital after the financial crisis may explain a deterioration in the time dimension of liquidity that may cause differences in opinion about corporate bond liquidity. My model relates the trade timing to the scarcity of capital, the bargaining power distribution and the dynamics of gains from trade. It also explains that investment funds with restrictive mandates, who are therefore limited to spot trades, are more affected by scarce capital.
"The Effect of Fiscal Capacity on Bank Risk Taking"
Abstract:
I study how fiscal capacity affects a bank's risk-taking in anticipation of a bail-out. The bank's future liquidity depends on the proportion of bad loans on its balance sheet. The government wants to increase the bank's liquidity by purchasing bad loans but needs to consider its own fiscal capacity (e.g. cost of sovereign debt). The bank anticipates that the generosity of the government's bail-out is inversely related to its fiscal capacity. Moral hazard, i.e. the bank's incentive to pursue a high-risk strategy with a high proportion of bad loans, diminishes when the cost of sovereign debt increases from a low level. Paradoxically, this does not apply for high levels of sovereign debt costs. At high levels of sovereign debt costs, the government will only make the lowest possible bail-out to prevent a complete liquidity breakdown, regardless of the bank's risk choice. The model implies: i) policy measures aiming at a decrease of bail-out expectations through an increase of (perceived) marginal cost of debt can reduce welfare and ii) an increase in fiscal capacity can paradoxically decrease the expected spending for bail-outs.