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This paper shows how firm-level productivity shocks propagate through financial networks. If firms need external funds to finance capital expenditure, banks create linkages between firms that go beyond their input-output relationship. These links affect aggregate output. I build a multi-sector input-output production model of heterogeneous firms that are financed by heterogeneous leverage targeting banks. Banks are themselves connected through bilateral cross-holdings. I show that endogenous financial asset prices introduce a new propagation channel of productivity shocks (financial network multiplier). Structural parameters determine the strength of this channel and one statistic is sufficient to capture it. I use dis-aggregated confidential French data on matched firm-bank relationships through corporate bond investments in the 2011 - 2015 period to estimate the model. The model can be used to study macro-prudential regulation and monetary policy.
NBER Working Paper No. 26049, July 2019, with Amine Ouazad and Romain Rancière
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The paper uses bank- and instrument-level data on asset holdings and liabilities to identify and estimate a general equilibrium model of trade in financial instruments shaping an endogenous network of interlinked banks' balance-sheets. Bilateral ties are formed as each bank selects the size and the diversification of its assets and liabilities. Shocks propagate due to the response, rather than the size, of bilateral ties to such shocks. This general equilibrium propagation of shocks reveals a financial network where the strength of a tie is determined by the sensitivity of an instrument's return to other instruments' returns. General equilibrium analysis predicts the propagation of real, financial and policy shocks. The network's shape adjusts endogenously in response to shocks, to either amplify or mitigate partial equilibrium shocks. The network exhibits key theoretical properties: (i) more connected networks lead to less amplification of partial equilibrium shocks, (ii) the influence of a bank's equity is independent of the size of its holdings; (ii) more risk-averse banks are more diversified, lowering their own volatility but increasing their influence on other banks. The general equilibrium based network model is structurally estimated on disaggregated data for the universe of French banks. The endogenous change in the network matters two to three times more than the initial network of cross-holdings for the transmission of shocks. We use the estimated network to assess the effects of the ECB's quantitative easing policy on asset prices, balance sheets, individual bank distress risk, and network systemicness.
with Joseph E. Stiglitz
Draft available soon
We study theoretically how idiosyncratic shocks propagate through supply chains when producers can switch suppliers. We argue that it is not so much currently observable supply chains but rather their sensitivity to shocks that matters. If new supply relationships are costly to establish, the production network plays a larger role in firm-level disturbances. On the other hand, if new relationships can be formed easily, there are backstops to shock propagation. This implies that a large part of the existing literature on production networks deals with a rather special case, where (i) either costs to switch suppliers are prohibitively large and/or (ii) disturbances are very small.
with Matthieu Bussière, Menzie Chinn and Laurent Ferrara
NBER Working Paper No. 24342, IMF Economic Review, forthcoming 2022
We re-examine the historically common finding that ex post depreciation and the forward premium is negatively correlated, termed the forward premium puzzle. When covered interest differentials are zero, this finding is equivalent to the rejection of the joint hypothesis of uncovered interest parity (UIP) and full information rational expectations. We term this result the Fama puzzle (1984), given the difficulty in identifying a time-varying risk premium that could rationalize this result. In our analysis, the rejection occurs for eight exchange rates against the US dollar, but does not survive into the period during and in the decade after the financial crisis. Strikingly, in contrast to earlier findings, the Fama coefficient – the coefficient on the interest differential – then becomes large and positive; this is what we term the New Fama Puzzle. Using survey based measures of exchange rate expectations, we find much more constant evidence in favor of UIP. Hence, the explanation for the switch in the Fama coefficient in the wake of the global financial crisis is mostly a change in how expectations errors and interest differentials co-move.
with Ilian Mihov and Ana Maria Santacreu
Journal of Economic Dynamics and Control, Elsevier, vol. 135, February 2022
We show that a monetary policy rule that uses the exchange rate to stabilize the economy can outperform a Taylor rule in managing macroeconomics fluctuations and in achieving higher welfare. The differences between the rules are driven by: (i) the paths of the nominal exchange rate and the interest rate under each rule and (ii) external habits in consumption, which leads to deviations from uncovered interest parity. These differences are larger in economies, which are very open, which are more exposed to foreign shocks, or in which domestic and foreign goods are highly substitutable.
with Romain Rancière and Natacha Valla
Journal of International Money and Finance, Elsevier, vol. 94(C), pp. 206-226, June 2019
This paper uses a unique comprehensive database on French security assets and liabilities to study the dynamics of domestic and external sectoral portfolios, their network structure, and their role in the propagation of shocks. We first show how the sharp deterioration of the net external portfolio position of France between 2008 and 2014 was driven by sectoral patterns such as the banking sector retrenchment and the increase in foreign liabilities of the public and corporate sectors, but was mitigated by the expansion of domestic and foreign asset portfolios of insurance companies. We also provide a network representation of the links between domestic sectors and the rest of the world, and document their evolution between 2008 and 2014. Second, we put forward and estimate a model of balance-sheet contagion through inter-sectoral security linkages. The estimation of the model shows that the financial sectors of the economy (banking, mutual fund, and insurance sector) are affected by balance-sheet contagion.
EconomiX Working Papers 2017-2, University of Paris Nanterre, 2017, with Pierre Bui-Quang and Natacha Valla
International portfolio diversification has been shown to be subject to several puzzles, notably the home bias in equity investment, and the correlation bias. Taken together, those facts suggest that not only do investors tend to prefer domestic equity to foreign equity, but that, when they venture into cross-border investments, they do so in countries where stock prices are most correlated with home markets - contradicting the intuition that international investments are used to diversify portfolios more optimally. Our paper deals mainly with the correlation bias. It uses a dataset on French external financial portfolio positions produced by the Banque de France that allows a security-by-security analysis of international positions. We show that although insurance companies and investment funds are indeed more exposed to highly correlated markets,the way they arrange their portfolios at the security-level is consistent with the existence of a diversification motive.
EIB Working Paper 2017/03, March 2017, with Philipp-Bastian Brutscher and Christopher Hols
This paper uses a unique experiment conducted as part of the EIB Investment Survey (EIBIS) to provide novel evidence on firms’ preferences over loan characteristics and the relation between terms of credit and investment decisions. The design of the experiment allows revealing firm’s financing preferences and willingness-to-pay in a clean and straightforward manner. The results show that firms are especially sensitive to the loan amount, the collateral requirement and the interest rate. Results are heterogeneous between sectors, size classes and types of projects
Newsletter #3, SCOR-PSE Chair on Macroeconomic Risk, December 2019.
Newsletter #2, SCOR-PSE Chair on Macroeconomic Risk, June 2019.
Newsletter #1, SCOR-PSE Chair on Macroeconomic Risk, December 2018.