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Research

Published Papers

The Downside of Asset Screening for Market Liquidity, Vol. 72, Issue 5, Pages 1937-1982, Journal of Finance, October, 2017

*Previously circulated as Information Acquisition vs. Liquidity in Financial Markets.

This paper explores the tension between asset quality and liquidity in a model where an originator exerts effort to screen assets, whose cash flows can be later sold in secondary markets. Screening improves asset quality, but introduces a problem of asymmetric information that may hinder trade. In the optimal mechanism, costly retention of cash flows is essential to implement positive effort. Market allocations can feature too-much or too-little effort relative to the second best, where over-exertion comes with inefficiently illiquid markets. When gains from trade are large, markets are prone to multiple equilibria. The optimal mechanism is decentralized with differential retention rules and transfers across markets.

Learning by Lending (with Mathew Botsch) - Forthcoming, Journal of Financial Intermediation. Online Appendix

This paper studies bank learning through repeated interactions with borrowers from a new perspective. To understand learning by lending, we adapt a methodology from labor economics to analyze how loan contract terms evolve as banks acquire new information about borrowers. We construct "proxy'' variables for this information using data from borrowers' out-of-sample, future credit performance. Due to the timing of their construction, banks could not have used these variables directly to price loans. We nonetheless find that these proxies increasingly predict loan prices as relationships progress, even after controlling for possible omitted variable bias. Our methodology provides strong evidence that: (a) bank learning affects loan prices, and (b) relationship benefits are heterogeneous. In particular, higher quality borrowers face differentially lower spreads as their relationship with lenders develop -- and banks learn about their quality -- while lower quality borrowers see loan prices increase and their loan amounts fall. We further find suggestive evidence that banks incorporate CEO-specific information into loan prices. 
 

Working Papers

Securitization, Ratings, and Credit Supply (with Brendan Daley and Brett Green) - Revise and Resubmit, Journal of Finance

We explore the effect of credit ratings on loan origination and securitization. The model involves two stages: first, banks decide whether to originate a given loan pool or not, and obtain private information about the pools originated. Second, each bank chooses what portion of the pool’s cash flow rights to retain and what portion to securitize. All securities are rated and sold to competitive investors. We characterize how credit ratings affect the trade-off between productive efficiency (i.e., efficiency of the origination process) and allocative efficiency (i.e., efficiency of the securitization process). In particular, we show that credit ratings increase allocative efficiency by reducing costly retention and increase the supply of credit, but reduce average quality of loans originated and can lead to an oversupply of credit relative to first best. These findings are in contrast to regulators view of credit ratings as a disciplining device. We consider extensions of the model to allow for rating shopping and manipulation. Provided investors are fully rational, shopping/manipulation have effects similar to reducing the informativeness of ratings. 

Security Design with Ratings (with Brendan Daley and Brett Green)

We investigate the effect of ratings on the security design problem of a privately informed issuer. We find that the presence of ratings has important implications for the form of security designed (e.g., equity, debt, etc.), the level of seller retention, and price informativeness. The model rationalizes the issuance of securities that are informationally insensitive (standard debt) and informationally sensitive (levered-equity), depending on the informativeness of ratings. Furthermore, we show that the introduction of sufficiently informative ratings efficiently increases market liquidity by decreasing the reliance on inefficient retention to convey high quality. Perhaps counterintuitively, the presence of informative ratings actually decreases the amount of information transmitted to investors and prices become less informative.
 

Investor Experiences and Financial Market Dynamics (with Ulrike Malmendier and Demian Pouzo) - Submitted

How do financial shocks affect investor behavior and market dynamics? Recent evidence suggests that individuals over-weigh personal experiences when forming beliefs and making investment decisions. To study the aggregate implications of such behavior, we propose an OLG model where agents learn from experience. We characterize a novel link between investor demographics and the dependence of prices on past dividends. Different cross-cohort experiences generate persistent heterogeneity in beliefs, portfolio choices, and trade. The model captures many features of asset prices, and produces new implications about the cross-section of asset holdings and market dynamics that are in line with the data.

 

We construct a dynamic model of financial intermediation in which changes in the information held by financial intermediaries generate asymmetric credit cycles as the ones documented by Reinhart and Reinhart (2010). We model financial intermediaries as “expert” agents who have a unique ability to acquire information about firm fundamentals. While the level of “expertize” in the economy grows in tandem with information that the “experts” possess, the gains from intermediation are hindered by informational asymmetries. We find the optimal financial contracts and show that the economy inherits not only the dynamic nature of information flow, but also the interaction of information with the contractual setting. We introduce a cyclical component to information by supposing that the fundamentals about which experts acquire information are stochastic. While persistence of fundamentals is essential for information to be valuable, their randomness acts as an opposing force and diminishes the value of expert learning. Our setting then features economic fluctuations due to waves of “confidence” in the intermediaries' ability to allocate funds profitably.