Publications

Extrapolation Bias and Robust Dynamic Liquidity Management with Alejandro Rivera  (Management Science 2021)

Working Papers

Knightian Uncertainty and Capital Structure: Theory and Evidence (R&R, the Review of Corporate Finance Studies)

Pass-Through Mutual Funds, Flow of Funds, and Asset Pricing Anomalies with Matthew Linn
Presented:  Maryland (Brown Bag) Monash Winter Finance Conference (Melbourne, Australia), International Behavioral Finance Conference (Chicago, scheduled), Sydney Banking and Financial Stability Conference (Australia, scheduled), Boca Finance Conference (Florida, scheduled)

Abstract: We explain the low-risk anomaly in stock returns, attributing it to demand pressure from mutual funds that pass through the flows from their investors. Our analysis shows that when investors chase returns, mutual funds with high-beta assets receive significantly larger flows following market fluctuations than those with low-beta assets, leading to greater demand pressure on high-beta assets. Due to the substantially inelastic demand for high-beta assets relative to low-beta assets, this pressure leads to more pronounced price impacts on high-beta stocks. Notably, we show that the beta anomaly is present only following uptrend markets, with the CAPM holding otherwise. Investors persistently allocate capital to high-beta funds during uptrends but adopt a more conservative approach in downtrends. This accumulated demand pressure leads to overpricing of high-beta stocks and lower expected returns. By controlling for market trends and related demand pressure, we effectively eliminate the negative risk-adjusted returns of high-beta stock portfolios.

Competition and Lending standards with Multidimensional Private Information with William Mann 

Abstract We investigate how loan terms respond to competition between lenders when borrowers have multidimensional private information. In our model, competitive lenders screen borrowers using contracts with an interest rate and a collateral requirement. Compared to a monopolistic lender, a competitive market offers uniformly lower collateral requirements, and a larger share of funded projects is negative NPV. The competitive market may be more or less efficient than the monopolist, depending on the deadweight cost of collateral and the degree of selection externalities. In principle, efficiency could be greatly improved by an uninformed regulator who completely controls the interest rate schedule. However, simpler policies such as minimum collateral or higher interest rates do little to improve efficiency.

Robust Security Design  with Uday Rajan  

Abstract:   We consider the optimal contract between an entrepreneur and investors in a moral hazard model when both parties have limited liability, are risk-neutral toward cash flow risk, and are ambiguity-averse. In the static setting, the first-best security is either convertible debt or levered equity. The optimal second-best security has an equity-like component in high cash flow states. Finally, if the two parties can renegotiate the contract after acquiring more information, the initial contract is risky debt. It is later renegotiated to a security with an equity component, and the conversion factor depends on the information acquired in the interim.

How Secure is Blockchain? with Ing-Haw Cheng
Presented:   Michigan  

Abstract:   I show that users' coordination can make the Blockchain insecure in equilibrium. Through the distributed trust property, the Blockchain system becomes more secure as more users participate in the system. However, it is costly but not impossible for an atomic attacker to sabotage the system (e.g., a “51%” attack). In the model, the rational users optimally transfer their wealth to the Blockchain to maximize expected gains but fail to internalize the likelihood of inviting the attacker even if they know the attacker’s strategy. The inefficiency increases with the presence of fanatics who underestimate the possibility of such attacks. I use global game techniques with users’ multidimensional private information to solve equilibrium strategies, a critical departure from standard global games.

Robust Dynamic Capital Structure 

Abstract:   I incorporate ambiguity-averse equity holders uncertain about the distribution of a firm’s assets into Leland's dynamic capital structure model (1994). My model shows the optimal default threshold increases with Knightian uncertainty, whereas it decreases with risk. When the effect of uncertainty dominates that of risk, a firm optimally defaults earlier than predicted by a traditional dynamic model with risk alone. My ambiguity-augmented model predicts substantially lower leverage ratios in comparison to the benchmark model of Leland (1994).