Knowledge that Transforms

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.

We investigate the impact of two central bank policies, asset purchases and asset lending, on the search frictions in the government bond market in Japan. We build a search-theoretic model to explore the impact of a central bank’s securities lending facility (SLF) by introducing a central bank as a lender. We test model predictions using intraday data from an electronic platform for Japanese government bonds. First, we find large-scale asset purchases (LSAPs) increase order imbalance in the repurchase agreement (repo) market. Threshold analysis reveals that asset purchase amounts exceeding 0.18% of the outstanding, which corresponds to 38.98% of our sample, cause a significantly higher imbalance. Second, the SLF has a floor effect on the repo rate by affecting dealers’ choices between the repo market and the SLF. Third, the novel friction measures we test show that LSAPs and the SLF have opposite influences on bargaining power in the repo market.

We make use of rich U.S. data to show that debt overhang significantly reduces firm asset-, capex-, and employee-growth. We show these contractions are likely driven by firm decisions as opposed to the result of credit constraints or changes in investment opportunities. Our measure of overhang – liabilities to cash flow — aligns with traditional theory and focuses on the importance of a firm’s debt servicing capacity. It further allows us to capitalize on the COVID-19 shock as a quasi-natural experiment to confirm the impact of overhang on firm investment and growth.

We describe the dimensions along which bank technologies differ from fintech competitors and construct a novel measure of a bank’s technology based upon its overlap with fintech firms in terms of granular product installation data. A one standard deviation increase in our financial technology measure is associated with an 8.3 percentage point increase in Paycheck Protection Program (PPP) loans in 2020Q2. We show that smaller banks benefited more from marginal technology gains, that technology facilitated out-of-area lending, and that technology complemented small banks’ branch-based in-area lending. In a difference-in-differences analysis, we show an outsized increase in small business lending growth in 2020 for high tech small banks relative to their peers.

This paper provides the first study on how management structure influences hedge fund performance and risk. We document that hedge funds less tied to traditional assets often choose solo management structures. Solo-managed funds outperform team-managed funds, exhibit better skills in market return, volatility, and crisis timing, and demonstrate greater activity in beta management, but have higher idiosyncratic and tail risks. They are also less likely to be liquidated, with fund flows less performance sensitive. Using a sample of switched funds, we find that fund performance, assets, and risk correlate with the management structure switching decision.

Private equity (PE) managers are required to invest their own money in the funds they manage. We examine the incentive effects of this ownership on the delegated acquisition decision. A simple model shows that PE managers select less risky firms and use more debt, the higher their ownership. We test these predictions for a sample of Norwegian PE funds, using managers’ wealth to capture their relative risk aversion. As predicted, the target company’s cash-flow risk decreases and leverage increases with the manager’s ownership scaled by wealth. Moreover, the overall portfolio risk decreases with ownership, mitigating widespread concerns about excessive risk-taking.

I study a registry-based dataset of Swedish mutual fund managers’ personal portfolios. The majority of managers do not invest personal wealth into the very same funds they professionally manage. The managers who do invest personal money into their funds subsequently outperform the managers who do not. The results suggest that fund managers, in contrast to regular investors, are certain about their ability to generate an abnormal return, or lack thereof, and invest their personal wealth accordingly.

Theoretically, one rationale for central clearing counterparties is the mitigation of inefficiencies associated with distressed asset sales. With novel archival data, I empirically study the first event in economic history during which a CCP successfully played this role: the global wool crisis of 1900. In the leading wool futures market in France, an inefficient equilibrium with fire sales and cascading defaults could be avoided due to price support provided by surviving CCP members. Cooperation to achieve price support–which is nowadays the main element of CCP auctions–could arise due to family relationships and cultural proximity between traders.

We develop a model in which there are firms and employees who care about profit-sacrificing higher purpose (HP) and those who do not. Firms and employees search for each other in the labor market. Each firm chooses its HP investment. When there is no social pressure on firms to adopt a purpose, HP dissipates agency frictions, lowers wage costs, yet elicits higher employee effort in firms that intrinsically value the purpose. However, social pressure to invest in HP can distort the HP investments of all firms and reduce welfare by making all agents worse off. Applications of these results to banking are discussed.

This study investigates the role of asymmetric information for the pricing, issuance volume, and design of innovative securities. By analyzing the information that structured product issuers provide to the investors of those products, we can identify specific sources of asymmetric information between the issuers and investors in this market. We show that issuers exploit this information friction to offer products to investors that appear more profitable for the issuer. In addition, we find that the friction induces issuers to design products with higher information asymmetry. Our results suggest that product issuers’ behavior increases information frictions in the financial system.