Knowledge that Transforms

An asset owner designs an asset-backed security and a signal about its value. After experiencing a liquidity shock and privately observing the signal, he sells the security to imperfectly competitive buyers. With flexible information design, the security’s informational sensitivity is a blessing, not a curse. Among double-monotone securities, the issuer prefers to sell the asset in combination with an appropriate signal rather than design more complex securities. Within the class of monotone securities, live-or-die securities are optimal and strictly dominate asset sales. When signals are restricted to be sufficiently informative about the upside, debt and additional-tier-1 debt become optimal.

Central banks increasingly disclose their private information regarding the economy’s current and future state (CBET). Consistent with CBET shifting investors’ collection and pricing of aggregate-level (where managers do not have an information advantage) toward firm-level (where managers do have an information advantage) information, we find that CBET reduces managers’ learning from stock price. The results are (1) pronounced when firms do not provide guidance and when noise trading in firms’ stock is low, and (2) robust to using the 2013–2014 amendments to the Bank of England’s Inflation Report as an exogenous shock. Additional evidence suggests that CBET lowers investment efficiency.

Using résumé data on over 20 million U.S. workers, we find that the flow of employees between a pair of firms sharply drops by about 20% during periods in which the firms share a board director. This relationship is stronger in settings where firms have greater potential gains from limiting worker mobility and is most pronounced for higher-skilled employees. Moreover, we find more connected firms have lower rates of internal promotion and no improvements in employee satisfaction. The evidence is consistent with shared directors serving as a mechanism for labor market coordination.

We introduce a nonlinear covariance shrinkage method for building optimal portfolios. Our universal portfolio shrinkage approximator (UPSA) is built from closed-form basis portfolios, is cheap to implement, and improves on existing shrinkage methods. Rather than uniformly penalizing all principal components of returns or discarding low-variance ones, UPSA instead reweights components to explicitly optimize expected out-of-sample portfolio performance. In empirical applications using a large cross-section of anomaly factors, it delivers robust improvements over alternative shrinkage methods in the literature.

We highlight the role of duration and exchange rate risks on portfolio flows by using a unique and comprehensive database of U.S. investor flows into emerging market government bonds denominated in local currency. Borrowing long-term mitigates rollover risk but amplifies valuation changes that further interact with currency movements. Our analysis highlights the double-edged nature of long-term borrowing and draws attention to market stress dynamics due to strategic complementarities among mutual fund investors.

This paper shows that high market concentration in the U.S. manufactured home loan market allows lenders to charge markedly higher interest rates than in the mortgage market for site-built homes. Borrowers in counties with higher lender concentration face significantly higher rates, and evidence from bunching at a regulatory rate threshold, an instrumental variable analysis, and a difference-in-differences analysis suggests a causal link. Integrated lenders, which play an outsized role in this market, charge particularly high rates, and we provide evidence suggesting that these lenders exploit their market power over borrowers. We discuss factors that may explain limited lender entry.

In a dynamic setting, high-quality firms may tolerate current adverse selection when raising financing because they expect future opportunities to profitably acquire assets from failed lower-quality firms. But search frictions in asset trading impede efficiency, inviting government intervention. Anticipation of such intervention affects ex ante adverse selection and project investment because it reduces buyers’ ex post trading profits. Depending on parameter values, this anticipation can have either pernicious or salutary effects. The pernicious effect reduces participation by high-quality firms, worsens adverse selection, and depresses project investment, potentially triggering investment-enhancing government assistance (an “intervention trap”). The salutary effect mitigates adverse selection and increases project investment.

Many economic questions require estimating the price effect of demand shifts (multipliers) in the bond market. Corporate bonds have salient characteristics that distinguish between close and distant substitutes. We show that accounting for heterogeneous substitutability between bonds is critical for correctly estimating multipliers. We find that security-level multipliers are very small. In fact, an order of magnitude smaller than the estimate ignoring heterogeneous substitutability. Nonetheless, portfolio multipliers are substantially larger and monotonically increase with the aggregation level. Furthermore, we find that the multiplier is larger for high-yield bonds, longer-maturity bonds, and bonds with greater arbitrage risks.

We study a dynamic trade-off model where shareholders can freely adjust debt but lack commitment to future debt policies. A debt policy is time-consistent if shareholders prefer it to deviating and losing credibility ex post. We characterize the optimal time-consistent policy in a class. It includes a stable regime, where shareholders actively manage liabilities to maintain the target interest coverage ratio, and a distress regime triggered by large negative shocks, where shareholders temporarily abandon the target. This policy has realistic properties and bridges the gap between the static trade-off theory of debt and theory based on the leverage ratchet effect.

Using the Duke Survey data on firms’ internal plans, we show that over 80% of Chief Financial Officer (CFO) forecasts align closely with simple heuristics taught in MBA textbooks. We introduce forecast coherence—internal consistency across forecasts of jointly determined variables—as a benchmark for evaluating these heuristics. Nearly half of CFOs issue forecasts closely aligned with incoherent heuristics. Such forecasts are associated with predictable reversals in forecast errors, lower firm performance, and underinvestment. We develop a parsimonious model illustrating how reliance on restricted forecasting heuristics can generate incoherence and resource misallocation within firms, consistent with our evidence