Knowledge that Transforms

The blockchain settlement layer facilitates systematic frontrunning, resulting in inefficient block-space allocation. Private transaction pools can reduce these inefficiencies and enhance welfare. However, full adoption is limited by misaligned incentives between users and validators. Validators are reluctant to forgo rents they earn from frontrunning – referred to as maximal extractable value – leading to a partial adoption equilibrium in which frontrunning persists. Our empirical analysis of Ethereum’s Flashbots private pool supports these findings: validators earn higher revenues, users facing greater frontrunning risk are more likely to use the private pool, and attackers’ cost-to-revenue ratios in private pools converge to one.

Frequent, yet uninformed, market timing recommendations by a financial advisory firm generate significant flows for Chilean pension funds. These flows induce substantial changes in the Chilean foreign exchange rate due to the funds’ high allocation to international securities. Local banks provide liquidity to pension funds in the spot market and their hedging transactions propagate the demand fluctuations from the spot to the forward market, resulting in deviations from covered interest rate parity. Using bank balance sheet data, we confirm that banks’ risk bearing constraints create limits to arbitrage.

We examine how stakes affect investor behaviors. In our unique setting, investors trade stocks in real accounts using their own money and simultaneously in a simulated setting. Our real-world within-investor estimation shows that investors exhibit stronger biases and perform worse in higher-stakes real accounts than in lower-stakes simulated accounts. Investors exhibit strong biases in both types of accounts, and the biases in both are strongly positively correlated. Such behavioral consistency suggests that low-stakes experiments are informative about real-world behaviors. Using additional account-level datasets, we demonstrate external validity by documenting a stronger (reverse) disposition effect on stocks (funds) with greater portfolio weights.

We propose a model of lending, payments choice, and privacy in the digital economy. While digital payments enable merchants to sell goods online, they reveal information to their lender. Cash guarantees anonymity, but limits distribution to less efficient offline venues. In equilibrium, merchants trade off the efficiency gains from online distribution (with digital payments) and the informational rents from staying anonymous (with cash). While new technologies can reduce the privacy concerns associated with digital payments, they also redistribute surplus from the lender to merchants. Hence, privacy enhancements do not always improve welfare.

Using a regime change in the commercialization of university innovation in 1980 that strongly increased university incentives to patent and license discoveries, we document that an increase in the supply of commercializable innovation attracts venture capital investment to the region. The Bayh-Dole Act shifted ownership of intellectual property stemming from federally-funded research from the federal government to universities, spurring technology transfer into the local area. Because universities have different technological strengths, each local area surrounding a university experienced an increase after 1980 in commercializable innovation relevant to particular sets of industries which differed widely across university counties. Comparing industries within a county that were more versus less related to the local university's innovative strengths, we show that venture capital dollars after 1980 flowed systematically towards geographic areas and industries affected most by the sudden influx of commercializable innovation from universities. These results persist even when controlling for ex ante geographic and industry distributions of corporate patenting and prior venture financing. The findings support the notion that increased supply of commercializable innovation serves to draw private capital investment to a region.

The Tax Cuts and Jobs Act unlocked as much as $1.7 trillion of U.S. multinationals’ foreign cash. We examine the real and financial response to this liquidity shock and find that firms did not increase capital expenditures, employment, R&D, or M&A, regardless of financial constraints. On the financial side, firms paid out only about one-third of the new liquidity to shareholders and retained half as cash. This high retention was not associated with poor governance. The high propensity to retain the liquidity shock as cash, even among well-governed firms with limited financial constraints, is difficult to reconcile with existing theory.

We document large racial disparities in the ability of homeowners to access their accumulated housing wealth. Minority homeowners are significantly more likely to have their mortgage equity withdrawal (MEW) product applications rejected than White homeowners, and the unconditional disparities are significantly larger than those found in prior studies that focused on purchase and rate/term refinance loans. Had Black homeowners faced the same MEW denial rate as White homeowners in our sample period we show they would have extracted an additional $11.2 billion in housing equity, or almost 25% of the total amount of actual equity extracted. Controlling for key underwriting variables significantly narrows the racial disparities, with the Black–White gap falling by nearly 85%, and the Hispanic-White gap falling by more than 75%. Credit scores and debt-to-income ratios are the most important factors explaining the gaps, while differences in loan-to-value ratios contribute only modestly. “Residual” disparities after conditioning on observable underwriting factors are large and vary significantly across lenders. A battery of tests suggests that differences in unobserved underwriting factors are unlikely to fully explain the residual disparities, which tend to be larger in geographic areas characterized by more racial animus.

Do federal tax incentives for banks investing in municipal bonds support local governments during recessions? This paper exploits a change in tax benefits for banks purchasing municipal bonds and finds that expanding access to bank financing during recessions increases local governments’ debt issuance and employment growth. The estimated job multiplier is 22 jobs per million dollars of spending. There is moderate evidence of mortgage loans being crowded out by banks’ increased holdings of municipal bonds.

Fluctuations in investor demand significantly affect firms’ valuation and access to capital. To quantify their real effects, we develop a dynamic investment model, incorporating both the demand and supply sides of capital. Strong investor demand relaxes financial constraints and facilitates equity issuance and investment, while weak demand encourages opportunistic share repurchases, crowding out investment. We estimate the model using indirect inference, matching the endogenous relationship between investor demand and firm policies. Our estimation reveals that demand fluctuations are important drivers of firm-level investment and economy-wide capital misallocation, accounting for 26.9% of dispersion in MPK and 23.4% of productivity losses.

We assess how nine different categories of market participants trade relative to a comprehensive forecasted-return variable based on 193 predictors. Firms and short sellers tend to be the smart money—both sell stocks with low-forecasted returns, and their trades predict returns in the intended direction. Retail investors trade against forecasted returns. Retail investors’ and institutions’ trades predict returns opposite to the intended direction. This poor trading performance is driven by trades in stocks with either high- or low-forecasted returns. The forecasted-return variable predicts returns more strongly in stocks with more intense retail trading, consistent with retail investors exacerbating mispricing.