Research

This paper investigates the interaction between financial risk and inflation in a small open economy context. The first section explores the time-series dimension, focusing on the co-movement between the market index and realized inflation, further decomposed into expected and unexpected components. Evidence suggests a structural break in the stock-inflation relationship around September 2008. Subsequent analysis of the inflation time series reveals that the expected component is the primary driver of this break. An attempt is made to explain these changes by incorporating additional explanatory variables into the time-series model, such as the Composite Index and investment/return on capital (ROC) following Fama (1981). The final section utilizes a panel of Israeli firms to estimate individual firm “inflation-betas” and constructs an inflation-HML portfolio to quantify the inflation risk premium (IRP), following Boons et al. (2020). The analysis reveals weak evidence for an IRP, while the quantity of risk exhibits a broad upward shift across all firms. These results suggest that Israeli equities may not be an effective instrument for hedging against inflation risk.

In many countries, financial institutions receive preferential treatment in bankruptcy. More specifically, interbank liabilities are given seniority over general claims, a policy designed to prevent cascading losses in the financial system. This paper investigates how seniority of interbank liabilities affect financial stability. I develop a model that features a trade-off between protecting banks versus short-term creditors. The model identifies a new channel by which preferential treatment in bankruptcy can increase the probability of a bank-run: risk sharing. This channel has been ignored by previous studies, which focus only on the benefit of reducing domino-effect contagion. In order to evaluate the relative importance of these two channels, I calibrate my model to the U.S. banking system between 1997-2007 and quantify the conditions under which the domino-effect dominates risk sharing. I find that large bankruptcy costs are required for the domino-effect to dominate the risk-sharing benefits of interbank credit exposures.

This paper develops a new methodology for evaluating systemic risk, focusing on the covariance between a firm’s fundamentals and its default risk: a stronger (more negative) covariance between the two indicates a heightened systemic risk. It is designed to capture structural changes to the endogenous threshold at which investors refuse to roll over a company's debt (as in Goldstein and Pauzner, 2005). Using this methodology, it brings to view new evidence about the effect of interbank credit exposures on financial stability. To this purpose, it investigates a panel of financial and non-financial companies, documenting the co-movement of firms’ fundamentals (defined by Merton’s Distance to Default) and default risk measures based on CDS prices. The sample includes a period of two years before and after a legislation that changed the U.S. bankruptcy code was enacted, which reduced interbank credit exposures. In all, I find no support that the new legislation enhanced systemic risk. Comparing American to European companies, I show that a four-year trend in weakening correlations slowed down for American firms just shortly before a legislation that changed the U.S. bankruptcy code was enacted -- but not so for European and British firms. Furthermore, I find that the financial sector’s pre-financial crisis correlations between fundamentals and default risk were either completely absent, or were small and of the opposite sign to the predictions of economic theory. This was the case both in Europe and in North America. In contrast, non-financial firms in both economic regions exhibited strong and statistically significant correlations that are consistent with economic theory. This contrast between the financial sector and other sectors suggests that market participants priced-in implicit government guarantees to the financial sector before the financial crisis of 2007-8.

This paper studies a stylized macroeconomic model in which a coordination problem between producers gives rise to non-negligible fluctuations in output, and consequently asset prices - even when exogenous risk is assumed to be negligible. In an otherwise standard setting I assume a downward nominal wage rigidity, and show that this implies a multiplicity of equilibria that can be Pareto ranked. Following Frankel et al. (2003), I go on to resolve equilibrium multiplicity using a global games approach. I then assume that exogenous variation is negligible and show that nevertheless non-negligible endogenous fluctuations in output persist in equilibrium. Finally, I extend the model to an infinite horizon OLG, and study asset pricing implications.