Knowledge that Transforms

When will a policy authority (PA) resolve a bank whose solvency is uncertain? Delaying resolution gives the PA time to obtain information about the bank’s solvency. Delaying resolution also gives creditors time to withdraw funds, raising the cost of bailing out depositors. The optimal resolution date trades off these costs with the option value of making a more efficient resolution decision given new information. Providing liquidity support buys the PA time to wait for information, but increases its losses if the bank turns out to be insolvent. The PA may therefore optimally delay the provision of liquidity support.

We empirically examine how venture capitalists adjust coinvestor relationships over time. We identify a fundamental trade-off where the benefits of familiarity are weighed against the opportunity costs of coinvesting with other syndication partners. Using US data, we find that venture capitalists dynamically adjust their relationship intensities by gradually disengaging from overly deep relationships. More centrally networked investors are more cautious with disengaging. In hot investment markets investors disengage more readily from existing relationships, but new relationships forged in hot market are less enduring. Perhaps surprisingly, we find a negative relationship between deeper prior relationships and investment performance.

Security design, which broadly speaking deals with the issue of designing optimal contractual mechanisms for overcoming various frictions between agents, is the subject of an extensive literature. This paper presents a review of recent work on security design and is organized around the applications of security design in various fields of finance starting with classic corporate finance applications such as capital structure and corporate governance, financial intermediation applications such as securitization and contingent capital, the interaction of market and security design, as well as emerging applications such as fintech, sustainable finance and healthcare finance. Future research is also discussed.

This paper studies whether financing constraints adversely affect renters by reducing maintenance. Consistent with a sensitivity of maintenance to financial resources, housing code violations increased after a change in the law that effectively decreased cash flows available to maintain some rent-stabilized buildings in New York City. The effect is most severe when financing constraints are present. Moreover, results of panel regressions using a dataset of 45 cities obtained with Freedom of Information Act (FOIA) requests are consistent with a hypothesis that buildings with higher LTV ratio mortgages have more code violations. Together, the results provide evidence that financing constraints reduce maintenance, an outcome that exacerbates the unintended consequences of rent control.

Financial intermediation has distinct value from transforming financial claims to create liquidity and mitigate risks. However, research and policy competition analyses often neglect this value or minimally account for it. We review findings to better incorporate this value. We suggest shifting the mix of individual services analyzed to better represent the distinct value, focusing more on topics closely aligned with the distinct value concept beyond individual services, and accounting for the multimarket nature of financial intermediation. We recommend attention on future competition with digital FinTech, BigTech, and DeFi firms and policies to best preserve the distinct value of financial intermediation.

Buy-and-hedge intermediaries are important investors in the convertible bond market as they intermediate between firms that require capital quickly and investors requiring time to assess the security. Their strategy requires them to manage the trade-offs involved with the costs and benefits of hedging. We find that prices of convertible securities reflect the costs that intermediaries incur when managing their positions. Especially cross-sectional and within-bond variation of intermediaries’ loan costs helps explain variation in convertible bond underpricing.

We develop a model in which credit ratings are endogenously coarse relative to the underlying default probabilities, and ratings precision is countercyclical. Ratings coarseness arises from the profit-maximizing behavior of rating agencies, and coarseness may maximize welfare even when greater ratings precision is costlessly available. Because the private outcome may differ from the socially desirable outcome, a social planner can improve welfare by putting a ceiling (floor) on the rating agency’s fee if the desired outcome is coarseness (precision). Strikingly, when information production is costless, ratings coarseness is socially optimal, but it does not arise in the laissez-faire equilibrium, thus inviting regulatory intervention.