Networks, Asset Pricing, Financial Stability, and Financial Intermediation.
Regulating Financial Networks: A Flying Blind Problem [PDF, May 4 2021]
I study the problem of regulating a network of interdependent financial institutions when a network-conscious policymaker is uncertain about its susceptibility to contagion. I show how uncertainty can compound market equilibrium inefficiencies and alter the scope of welfare-improving interventions. I further demonstrate how optimal interventions depend on a delicate balance between the network architecture and the knowledge available to policymakers.
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.
Imperfect Information Transmission from Banks to Investors: Macroeconomic Implications [PDF] [Journal of Monetary Economics, Volume 118, March 2011, pages 87-98] (joint with Oksana Leukhina and Nicolás Figueroa)
Our goal is to elucidate the interaction of banks’ screening effort and strategic information production in loan-backed asset markets using a general equilibrium framework. Asset quality is unobserved by investors, but banks may purchase error-prone ratings. The premium paid on highly rated assets emerges as the main determinant of banks’ screening effort. The fact that rating strategies reflect banks’ private information about asset quality helps keep this premium high. Conventional regulatory policies interfere with this decision margin, thereby reducing signaling value of high ratings and exacerbating the credit misallocation problem. We propose a tax/subsidy scheme that induces efficiency.