Networks, Asset Pricing, and Financial Intermediation.
Regulating Financial Networks Under Uncertainty
I study the problem of regulating a network of interdependent financial institutions that is prone to contagion when there is uncertainty regarding its precise structure. I show that such uncertainty reduces the scope for welfare-improving interventions. While improving network transparency potentially reduces this uncertainty, it does not always lead to welfare improvements. Under certain conditions, regulation that reduces the risk-taking incentives of a small set of institutions can improve welfare. The size and composition of such a set crucially depend on the interplay between (i) the (expected) susceptibility of the network to contagion, (ii) the cost of improving network transparency, (iii) the cost of regulating institutions, and (iv) investors' preferences.
Firm Networks and Asset Returns [PDF, Feb 1 2018] [Revise and Resubmit, The Review of Financial Studies]
Changes in the propagation of idiosyncratic shocks along firm networks are important to understanding variations in asset returns. When calibrated to match key features of supplier-customer networks in the United States, an equilibrium model in which investors have recursive preferences and firms are interlinked via enduring relationships generates long-run consumption risks. Additionally, the model matches cross-sectional patterns of portfolio returns sorted by network centrality, a feature unaccounted for by standard asset pricing models.
We study the interaction of information transmission in loan-backed asset markets and screening effort in a general equilibrium framework. Originating banks screen their borrowers, but inform investors of their asset type only through an error-prone rating technology. The premium paid on highly rated assets emerges as the main determinant of screening effort. Because the rating technology is imperfect, this premium is insufficient to induce the efficient level of screening. Mandatory rating and mandatory ratings disclosure policies interfere with this decision margin, thereby reducing informativeness of high ratings, lowering their premium, and exacerbating the credit misallocation problem. Policies that increase accuracy and/or cost of rating technology can help restore efficiency.
Basket Securities in Segmented Markets [PDF, Dec 22 2017]
Basket securities are securities that bundle different assets and whose payoffs depend on those of the underlying pool of assets, such as index funds and exchange-traded funds (ETFs). I study the design and welfare implications of basket securities issued in markets with limited investor participation in which profit-maximizing intermediaries are involved in financial innovation. I show that when only one intermediary exists, the equilibrium is not constrained efficient. Increasing competition among intermediaries increases the variety of baskets issued but does not necessarily improve investors’ welfare.