Knowledge that Transforms

We use novel monthly survey data from 1993 to 2012 on small business managerial perceptions of financial constraints and other conditions, matched with information on banks in their local markets. The data suggest that small banks have comparative advantages in alleviating these constraints. These advantages tend to be greater during adverse economic conditions and do not appear to decrease or increase secularly. Small banks also appear to have comparative advantages in providing liquidity insurance to small business customers of large banks experiencing liquidity shocks during financial crises. Our findings suggest a source of social costs from ongoing consolidation of the banking industry.

Weather is a key source of income risk, especially in emerging market economies. This paper uses a randomized controlled trial involving Indian farmers to study how an innovative rainfall insurance product affects production decisions. We find that insurance provision induces farmers to invest more in higher-return but rainfall-sensitive cash crops, particularly among educated farmers. This shift in behavior occurs ex ante, when realized monsoon rainfall is still uncertain. Our results suggest that financial innovation can mitigate the real effects of uninsured production risk.

This paper uses segmented dual-class shares of Chinese firms—A shares traded in mainland China by local investors and H shares traded in Hong Kong by foreign investors—to document a rich pattern in the differential reactions of local and foreign investors to analyst recommendations. This pattern reveals that social connections between analysts and investors affect investor reactions to analyst recommendations. Because of the investors' differential reactions, analyst recommendations may exacerbate, rather than attenuate, the market segmentation between the two share classes.

Size-discovery mechanisms allow large quantities of an asset to be exchanged at a price that does not respond to price pressure. Primary examples include "workup" in Treasury markets, "matching sessions" in corporate bond and CDS markets, and block-trading "dark pools" in equity markets. By freezing the execution price and giving up on market-clearing, size-discovery mechanisms overcome concerns by large investors over their price impacts. Price-discovery mechanisms clear the market, but cause investors to internalize their price impacts, inducing costly delays in the reduction of position imbalances. We show how augmenting a price-discovery mechanism with a size-discovery mechanism improves allocative efficiency.

We examine the daily activity and performance of a large panel of individual investors from Sweden’s Premium Pension System. We find that active investors earn higher returns and risk-adjusted returns than do inactive investors. A performance decomposition analysis reveals that most outperformance by active investors is the result of active investors successfully timing mutual funds and asset classes. While activity is beneficial for some investors, extreme flows out of mutual funds affect funds’ net asset values negatively for all investors. Financial advisors, by contributing to coordinate investments and redemptions, exacerbate these negative effects. Received March 10, 2015; editorial decision September 8, 2016 by Editor Andrew Karolyi

Banks’exposure to large-scale asset purchases, as measured by the relative prevalence of mortgage-backed securities on their books, affects lending following unconventional monetary policy shocks. Using a difference-in-differences identification strategy, this paper finds strong effects of the first and third round of quantitative easing (QE1 and QE3) on credit. Highly affected commercial banks increase lending by 2% to 3% relative to their counterparts. QE2 had no significant impact, consistent with its exclusive focus on Treasuries sparsely held by banks. Overall, banks respond heterogeneously, and the type of asset being targeted is central to QE.

Mortgages are long-term loans with nominal payments. Consequently, in incomplete asset markets, monetary policy can affect housing investment and the economy through the cost of new mortgage borrowing and real payments on outstanding debt. These channels, distinct from the traditional real rate channel, are embedded in a general equilibrium model. The transmission mechanism is stronger under adjustable-rate mortgages compared with fixed-rate mortgages. Further, persistent monetary policy shocks affecting the level of the nominal yield curve have larger real effects compared with transitory shocks. Persistently higher inflation gradually benefits homeowners under FRMs, but hurts them immediately under ARMs.

I study asset price amplification in an asymmetric information model. Entrepreneurs issue debt to finance investments in a physical asset. They have private information about their success probabilities. For a given debt level, higher asset prices require entrepreneurs to invest more of their own funds. This makes bad entrepreneurs more reluctant to mimic good ones; as a result, good entrepreneurs increase their equilibrium leverage and invest more, and this amplifies the initial asset price increase. This model generates predictions about the credit market that are qualitatively consistent with existing evidence.

We propose an amplification mechanism of financial crises based on the information choices of investors. Information acquisition makes investors more likely to act against their prior. Deteriorating public news under an initially strong (weak) prior increases (reduces) the value of private information and induces more (less) information acquisition. Deteriorating public news increases the probability of a crisis, since the initially strong (weak) prior induces no attacks (attacks). This effect is amplified with endogenous information choices. To enhance financial stability, a policy maker affects information acquisition via taxes and subsidies. We derive and discuss testable implications for the magnitude of amplification.

We investigate the development of an innovative and high-risk type of borrowing for local governments, known as structured loans. Using transaction data for more than 2,700 local governments in France, we show that the adoption of these instruments is more frequent for politicians from highly indebted local governments, from politically contested areas, and during political campaigns. Taking on structured loans helps incumbents win a reelection, and initially allows them to maintain lower taxes. Our findings illustrate how financial innovation can amplify principal-agent problems within the political system.