Knowledge that Transforms

Employing a novel control function regression method that accounts for the endogenous matching of banks and executives, we find that equity portfolio vega, the sensitivity of executives’ equity portfolio value to their firms’ stock return volatility, leads to systemic risk that manifests during subsequent economic contractions but not expansions. We further find that vega encourages systemically risky policies, including maintaining lower common equity Tier 1 capital ratios, relying on more run-prone debt financing, and making more procyclical investments. Collectively, our evidence suggests that executives’ incentive-compensation contracts promote systemic risk-taking through banks’ lending, investing, and financing practices.

Using detailed loan holding data of Collateralized Loan Obligations (CLOs), we document empirical evidence for the fire sale of leveraged loans due to leverage constraints on CLOs. Constrained CLOs are forced to sell loans downgraded to CCC or below, and thus loans widely held by constrained CLOs experience temporary price depreciation. This instability is exacerbated by diversification requirements. As the CLO market grows, each CLO’s effort to diversify its portfolio leads to similarity in loan holdings among CLOs, and thus their leverage constraints simultaneously bind. CLOs’ overlapping loan holdings spread idiosyncratic shocks to large borrowers to the overall leveraged loan market.

We show that the COVID-19 pandemic brought house price and rent declines in city centers, and price and rent increases away from the center, thereby flattening the bid-rent curve in most U.S. metropolitan areas. Across MSAs, the flattening of the bid-rent curve is larger when working from home is more prevalent, housing markets are more regulated, and supply is less elastic. Housing markets predict an urban revival with urban rent growth exceeding suburban rent growth for the foreseeable future, as working from home recedes.

Bond underwriters, lacking “Greenshoe options” and formal systems to track “flipping” activity, have fewer tools than equity underwriters to manage secondary market order flow uncertainty. We show that bond underwriters respond by selectively “overallocating” some issues to attain net short positions. Overallocations are economically substantive, facilitate the syndicate's price stabilization efforts, and are largely offset in the days after issuance. These issues on average experience more net selling by institutional investors and, despite large syndicate purchases, appreciate less in the secondary market. Thus, overallocation is an observable indicator that underwriters anticipate weakness in net secondary market demand.

We analyze the strategic interaction between undercapitalized banks and a supervisor in a recovery and resolution framework in which early recapitalizations can prevent later disorderly failures. Capital forbearance emerges because reputational, political, economic and fiscal costs undermine supervisors’ commitment to publicly resolve the banks that miss the request to privately recover. Under a weaker resolution threat, banks’ incentives to recover are lower and supervisors may end up having to resolve more banks. When marginal resolution costs steeply increase with the scale of the intervention, private recovery actions become strategic complements, producing too-many-to-resolve equilibria with high forbearance and high systemic costs.

We show that negative interest rate policy (NIRP) has expansionary effects on credit supply through a portfolio rebalancing channel. By shifting down and flattening the yield curve, NIRP differs from rate cuts just above the zero-lower-bound and has effects similar to QE. For identification, we exploit ECB’s NIRP and the Italian credit register and, for external validity, European and U.S. datasets. NIRP affects more banks with higher ex-ante liquid assets, including net interbank positions. More exposed banks reduce liquid assets, expand credit supply, especially to financially-constrained firms, and cut loan rates, inducing firms to increase investment and the wage bill.

We examine systemic risk in the interbank market. We first establish that in the German interbank lending market, a few large banks intermediate funding flows between many smaller periphery banks. We then develop a network model in which banks trade off the costs and benefits of link formation. The model is structurally estimated using banks’ preferences as revealed by the observed network structure before the Great Financial Crisis. In out-of-sample tests, model estimates based on pre-crisis data successfully predict changes in the network structure and lending to firms during the Great Financial Crisis. Finally, for each of the intermediaries, we quantify systemic risk and the impact of European Central Bank funding in reducing this risk.

This paper estimates the impact of requiring high school students to complete personal finance education on federal student loan repayment behavior after college. I merge student loan borrowing and repayment data from the College Scorecard with data from the Integrated Postsecondary Education Data System on counts of high school graduates enrolling in college from different states. I estimate the causal effect of personal finance education mandates by relating the change in the share of university students subject to a state mandate to changes in university cohort student loan outcomes. I find only students with higher-income parents respond by adjusting borrowing, reducing median balances by 7%. By contrast, first-generation and low-income borrowers bound by mandates did not significantly adjust borrowing, but were nonetheless more likely to pay down balances. Repayment improvements are in part due to better understanding of the terms governing federal student loans. State mandates that incorporate career research alongside personal finance education are associated with better student loan repayment than those focused only on personal finance education.

We examine the characteristics of the individuals who become entrepreneurs when local opportunities arise. We identify local demand shocks by linking fluctuations in global commodity prices to municipality-level agricultural endowments in Brazil. We find that the firm creation response is mostly driven by young and skilled individuals. The characteristics of these responsive entrepreneurs are significantly different from those of average entrepreneurs in the economy. By structurally estimating a novel two-sector model of a local economy, we highlight how the demographic composition of the local population can significantly affect the entrepreneurial responsiveness of the economy.

Open-end corporate bond mutual funds invest in illiquid assets while providing liquid claims to shareholders. Does such liquidity transformation introduce fragility to the corporate bond market? To address this question, we create a novel bond-level latent fragility measure based on asset illiquidity of mutual funds holding the bond. We find that corporate bonds bearing higher fragility subsequently experience higher return volatility and more outflows-induced mutual fund selling over the period of 2006–2019. Using the COVID-19 crisis as a natural experiment, we find that bonds with higher precrisis fragility experienced more negative returns and larger reversals around March 2020.