Since I received my Ph.D. in 2008, I have published papers on the areas of firm finance, household finance, and sovereign default.
My research has focused on the aggregate implications of frictions faced by three class of agents in financial markets. In particular, I have investigated the relationship between firms and financial markets, the implications of household financing in credit card and mortgage markets and unemployment insurance, and the role of credit market imperfections and institutional factors on sovereign default risk and the business cycle dynamics of emerging market economies.
Early in my career, I became very interested in the effects of financial market efficiency on a country's macroeconomic performance. This is the most extensive part of my research agenda, and as of today I remain fascinated by how different arrangements may be implemented to overcome the information and commitment problems that arise when a person finances another person's venture.
In joint work with Jeremy Greenwood and Cheng Wang, we studied the impact of improvements in financial markets, which allows investment to be directed toward the most profitable production opportunities in the economy, thereby increasing income and productivity. One key contribution of that paper, which we published in the American Economic Review in 2010, is that we model intermediation using the costly-state verification framework, which is embedded into the standard growth model. We quantitatively evaluate the importance of this mechanism in a paper published in the Review of Economic Dynamics in 2013. We find that the observed differences in financial efficiency across countries can generate large differences in output per worker and TFP.
One key feature missing in those papers is that firms and financiers usually have long-term relationships. It is well-known in contract theory that those relationships may be useful to overcome informational frictions. My following paper on this topic, joint with Harold Cole and Jeremy Greenwood, published in Econometrica in 2016, introduces that missing ingredient. The key quantitative advantage of this new modeling strategy is that we were able to relate our model with new facts about differences in the life-cycle of plants across countries---in particular, the fact that firms in the US grow more than similar firms in Mexico and India. We show that differences in the efficiency of the financial system resolving information and enforcement problems can induce entrepreneurs in emerging economies like India and Mexico to adopt less-promising ventures than in the United States. Thus, this paper highlights the efficiency of the US financial markets to finance small firms that eventually may become very successful.
In a current working paper with Jeremy Greenwood and Pengfei we focus precisely on the financing of very innovative start-ups by venture capital (VC) firms. In that project, we develop a new dynamic contract that incorporates the main features of VC, embed that contract into an endogenous growth model, and explore how efficiency in financial markets affects technology adoption and growth. The model matches several stylized facts of the venture capital process by funding rounds. We use the model to analyze the role of taxation of successful start-ups. Preliminary results suggest that raising the tax on VC-funded startups from the U.S. rate of 15 percent to an Italian rate of 75 percent would shave 0.25 percentage points of growth and lead to a consumption equivalent welfare loss of 4.3 percent.
In all the papers mentioned above, and in most of the literature, an entrepreneur must obtain external resources from a financier who is not directly involved in the venture. In a paper accepted for publication at the Journal of Economic Theory with Emilio Espino and Julian Kozlowski, we considered partnerships between the business owners as an alternative to external financing. In particular, that paper, which is conditionally accepted at the Journal of Economic Theory, focuses on studying the bilateral long-term relationship between the owners. We answer questions such as: How is investment distorted? and, How is investment affected by the distribution of ownership among partners? The key finding is that partners with more ownership shares have fewer incentives to cheat and, as a consequence, the allocation of investment and consumption of the partners may be undistorted if both partners have equal ownership shares.
The idea that financial systems may help to explain differences in income across countries leads to a more general question: How efficient is the world allocation of capital? We provide an answer to this question in a working paper joint with Alexander Monge-Naranjo and Raul Santaeulalia-Llopis. The key contribution of this paper, which is accepted for publication at the American Economic Journal: Macroeconomics, is that it provides a better measurement of marginal products of capital for a sample of more than 100 countries since 1970 to 2005. In sharp contrast with previous literature, we find a significant and persistent degree of misallocation of physical capital. The key difference with previous work is a new method to measure the share of natural resources in the aggregate production function of a country.
My interest in firm financing also led me to study their behavior during the US financial crisis of 2008. In a recent empirical paper with Marianna Kudlyak, which was published in the Journal of Economic Dynamics and Control in 2017, we study the behavior of small and large firms during the episodes of credit disruption and extend the analysis to the 2008 financial crisis and NBER-dated recessions. We find that large firms' short-term debt and sales contracted relatively more than those of small firms during the 2008 financial crisis and during most recessions since 1969. The results suggest that a "credit crunch'' or "tight money period'' may not be the best way to characterize the 2008 financial crisis.
The relevance of long-term firm financing is an issue that I am currently studying in joint work with Rody Manuelli. We introduce a simple theory of corporate debt maturity determination with default. At the time of issuing debt firms are in the illiquid phase: they cannot issue equity, have very little income, and must pay a fixed issuance cost. During this phase, firms may default on projects with positive expected discounted value. In the future, firms will have higher and more volatile income, and they will be able to issue equity. During this second phase, firms default only if the value of their debt if larger than expected discounted profits; i.e. strategic default. The duration of the first phase is uncertain, so firms would like to issue long-term debt to avoid defaults during the illiquid phase. However, increasing maturity increases the risk of strategic default because debt must be issued for a larger amount to compensate for the longer maturity. We are currently working on the characterization of the model. This working paper is now available.
As I mentioned above, I am also interested in studying households finance and insurance. One of the main risks faced by households is unemployment risk. Some of the first papers I wrote studied how to provide insurance against the risk of unemployment in a setup with moral hazard. My first paper answered a simple question: How should the duration of unemployment payments vary over the business cycles? This paper, which was published in Economics Letters in 2008, shows in a repeated moral hazard setup that payments should decrease more slowly during economic recessions.
My interest in unemployment insurance led me to think that it was necessary to incorporate an informal sector in the benchmark unemployment insurance model. I did that in a paper with a classmate, Fernando Alvarez-Parra, which was published in the Journal of Monetary Economics in 2009. We find that the optimal unemployment insurance system in an economy with a hidden labor market is simple, with an initial phase in which payments are relatively flat during unemployment and with no payments for long-term unemployed individuals. This scheme differs substantially from the one prescribed without a hidden labor market and resembles unemployment protection programs in many countries. Related, more recently I worked with Fernando Cirelli and Emilio Espino in the Designing UISAs for Developing Countries in a new working paper that is now available.
In the US, households usually rely on credit cards markets for insurance against income shocks. One interesting fact was the sharp rise in consumer bankruptcies between 1985 and 2005. During the same period, there was impressive technological progress in the information sector. I documented that other characteristics of the market also changed. Importantly, interest rates varied systematically with the borrowers' characteristics in 2004 but not in 1983. I introduced a model of unsecured borrowing with costly information to analyze the hypothesis that changes in the cost of information may account for the rise in bankruptcy. In quantitative exercises, I show that information costs indeed account for a large share of the changes in bankruptcies. This paper was published in Economic Inquiry in 2017.
Perhaps due to the sharp increase in consumer bankruptcies, in 2005 reforms made formal personal bankruptcy much more costly. Shortly after, the US began to experience its most severe recession in seventy years, and while personal bankruptcy rates rose, they rose only modestly given the severity of the rise in unemployment. In contrast, informal default through delinquency rose sharply. In a paper with Kartik Athreya, Xuan Tam, and Eric Young, which was published in the Review of Economic Dynamics in 2015, we modeled informal bankruptcy (also referred as delinquency) in credit card debt. This was a key missing ingredient in previous models of unsecured debt. We used the model to evaluate the consequences of the reform. Our results suggest that bankruptcy reform likely prevented a substantial increase in formal bankruptcy filings, but had an only limited effect on informal default from delinquencies. In a working paper with the same coauthors, we use a variety of microeconomic data sources to construct a salient set of facts on the use of unsecured debt and both formal and informal default. We then show that these facts, which describe both the cross-sectional and dynamic behavior of borrowing and default, can be well understood through a quantitative model of consumer credit with empirically plausible representations of labor market risks. This paper is forthcoming in International Economic Review.
While bankruptcy allows households to have a fresh start, because they discharge all their unsecured debt, informal default can last for a long time and the high interest rates charged during this period may worsen even more the household financial condition. With this in mind, in a working paper with Kartik Athreya and Jose Mustre-del-Rio, which is accepted in the Review of Financial Studies, we are studying the persistence of households financial distress. Using recently available proprietary panel data, we show that while many (35\%) US consumers experience financial distress at some point in the life cycle, most of the events of financial distress are primarily concentrated in a much smaller proportion of consumers in persistent trouble. Using a workhorse model of defaultable debt, we argue that our findings suggest the existence of large heterogeneity in time preference.
While credit card debt and default are very interesting, the largest liability of a household is mortgage debt. Following the financial crisis of 2008, mortgage defaults generate large debate among economists. In a paper with Juan C. Hatchondo and Leonardo Martinez, which was published in Journal of Monetary Economics in 2015, we propose a life-cycle model in which households face income and house-price risk and buy houses with mortgages. This model, which accounts for key features in U.S. data, is used as a laboratory for prudential policy. We find that combining recourse mortgages and LTV limits reduces the default rate while boosting housing demand. Together, they also prevent spikes in default after large declines in aggregate house prices.
Finally, I have been also interesting on emerging markets finance. Debt and default are also prevalent among emerging economies. As a consequence, similar models have been used to studies important question for developing countries. Part of my work in this literature has focused on different policy implications of sovereign credit default risk. Fiscal policy in emerging market economies tends to be procyclical: public expenditures rise (fall) in economic expansions (recessions), whereas tax rates rise (fall) in bad (good) times. In a paper with Gabriel Cuadra and Horacio Sapriza, which was published in the Review of Economic Dynamics in 2010, we contribute to the literature on fiscal policy and macroeconomic fluctuations by exploring the role of incomplete markets and sovereign default risk premium in explaining the procyclicality of public expenditures and tax rates. We help rationalize this fiscal procyclicality as the outcome of optimal public policy, based on the tightening of borrowing constraints in bad times through endogenous credit risk dynamics.
More recently, in a paper accepted at the Journal of Monetary Economics with Horacio Sapriza and Emircan Yurdagul, we propose a novel model of endogenous sovereign debt maturity choice that rationalizes various stylized facts about debt maturity and the yield spread curve. We expect our model to be used for many questions in the context of sovereign default with endogenous maturity. We actually improved the methodology in this paper by smoothing the problem using dynamic discrete choice in a new working paper with Max Dvorkin, Horacio Sapriza, and Emir Yurdagul in which we study Sovereign Debt Restructurings. With the same coauthors and methodology, we have a new working paper that studies News, Debt Maturity, and Sovereign Default.