Publications
Journal of Monetary Economics, forthcoming
Using the context of the dry-bulk shipping industry, I document that future returns on real assets are strongly predictable and negatively related to current asset prices, earnings, and investment during recessions. However, there is no such relationship outside recessions. This evidence points to significant liquidity constraints faced by firms during downturns, resulting in cash-in-the-market pricing of capital and rising expected returns for buyers. It is puzzling, however, why firms would not exploit opportunities to buy assets cheaply in recessions, e.g. by pre-arranging credit lines. I build and estimate a model of a competitive industry with credit frictions that can quantitatively account for return predictability during downturns, even though firms can use state-contingent contracts to preserve liquidity for when they need it most. Firms’ relative impatience limits their risk management, meaning that even well-capitalized firms can become constrained following adverse shocks. This results in significant asymmetric amplification of shocks in equilibrium.
Working papers
While financial crises tend to be preceded by economic booms, most booms do not end with crises. Crises typically occur when booms are interrupted by persistent slowdowns in productivity growth. I develop a model in which risk of crisis emerges endogenously during boom because of increased fragility of the banking sector. Banks raise financing from households to invest in long-term projects, but their ability to do so is hindered by moral hazard, since bankers can misappropriate investors’ funds. Demandable deposits create discipline by exposing misbehaving banks to runs, and thus help them increase external financing. Normally, banks finance themselves with a mix of equity and deposits that maximizes discipline, but ensures that they always remain solvent. But when growth prospects become sufficiently strong, worsening agency problems induce banks to intensify deposit financing, which enables a boom in credit, asset prices, and investment. If the anticipated growth fails to materialise, however, the excessive deposit financing leads to a systemic banking crisis.
Liability-driven investors and monetary transmission (with Giacomo Carboni and Martin Ellison)
Revise and Resubmit at the Journal of Money, Credit and Banking
The ability of monetary policy to influence the term structure of interest rates and the macroeconomy depends on the extent to which financial market participants prefer to hold bonds of different maturities. We introduce such preferred-habitat demand in a fully-specified dynamic stochastic general equilibrium model of the macroeconomy where the term structure is arbitrage-free. The source of preferred habitat demand is an insurance fund that issues annuities and adopts a liability-driven investment strategy to minimise the duration risk on its balance sheet. The behaviour of the insurance fund implies a liability-driven demand function that is upward-sloping in bond prices and downward-sloping in bond yields, especially when interest rates are low. This supports the operation of a recruitment channel at low interest rates, whereby long-term interest rates react strongly to short-term policy rates or unconventional policy because of complementary changes in term premia induced by liability-driven demand. The strong reaction and enhanced monetary transmission extend to inflation and output in general equilibrium.
Work in progress
We propose a unified theory connecting countries’ levels of financial development, volatility in their long-term growth, and the incidence of financial crises and Sudden Stop episodes. At the core of this relationship is the financing of long-term investments with short-term debt, the extent of which is endogenously determined depending on the degree of financial frictions. It is easier for firms in countries with a high level of financial development to attract long-term funding, resulting in advanced economies having stable growth and very rare financial crises. In emerging economies, however, projects are financed with short-term debt due to lack of financial enforcement. This facilitates growth, but introduces significant systemic capital flow risk, resulting in frequent crises. Lastly, countries with very weak financial development cannot borrow even short-term, since they would be too risky. Such countries experience no financial instability, but also grow extremely slowly.
Executive compensation in high-growth no-dividend firms (draft available upon request)
I study managerial compensation in financially constrained firms with high growth opportunities. Such firms can often profitably reinvest their operating incomes and pay no dividends. Absence of reliable performance indicators together with asymmetric information create acute agency problems. Stock-based compensation schemes, notoriously popular during the tech bubble of the 1990s, provide the necessary incentives for the manager to exert costly effort to pursue further growth. However, in line with the previous literature, I find that they may also induce the manager to conceal bad news about the future prospects of the firm, in order to maintain a high stock market valuation. This leads to a substantial overinvestment in the firm's assets, and expands a bubble-like surge in the firm's stock price, followed by an inevitable crash. I find that a stock-based compensation contract that delays payments by several years effectively deters the manager from concealing, while still providing incentives to work hard.