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8 resources
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FT50 UTD24 A*
We analyze a model where investors use a credit rating to decide whether to finance a firm. The rating quality depends on unobservable effort exerted by a credit rating agency (CRA). We study optimal compensation schemes for the CRA when a planner, the firm, or investors order the rating. Rating errors are larger when the firm orders it than when investors do (and both produce larger errors than is socially optimal). Investors overuse ratings relative to the firm or planner. A trade-off in providing time-consistent incentives embedded in the optimal compensation structure makes the CRA slow to acknowledge mistakes.
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FT50 UTD24 A*
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FT50 UTD24 A*
During the financial crisis that started in 2007, the U.S. government has used a variety of tools to try to rehabilitate the U.S. banking industry. Many of those strategies were also used in Japan to combat its banking problems in the 1990s. There are also a surprising number of other similarities between the current U.S. crisis and the recent Japanese crisis. The Japanese policies were only partially successful in recapitalizing the banks until the economy finally started to recover in 2003. From these unsuccessful attempts, we derive eight lessons. In light of these eight lessons, we assess the policies the U.S. has pursued. The U.S. has ignored three of the lessons and it is too early to evaluate the U.S. policies with respect to four of the others. So far, the U.S. has avoided Japan's problem of having impaired banks prop up zombie firms.
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FT50 UTD24 A*
ABSTRACT What ties together the traditional commercial banking activities of deposit-taking and lending? We argue that since banks often lend via commitments, their lending and deposit-taking may be two manifestations of one primitive function: the provision of liquidity on demand. There will be synergies between the two activities to the extent that both require banks to hold large balances of liquid assets: If deposit withdrawals and commitment takedowns are imperfectly correlated, the two activities can share the costs of the liquid-asset stockpile. We develop this idea with a simple model, and use a variety of data to test the model empirically.
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FT50 A*
We modify the 1983 Diamond and Dybvig model so that banks offer liquidity services to depositors, raise equity funding, make risky loans, and invest in safe, liquid assets. Banks monitor borrowers to ensure that they repay loans and they are susceptible to depositor runs. We model the run decision by solving a novel global game. Relative to a social planner, banks opt for a more deposit-intensive capital structure, their assets may be more or less lending intensive, and the level of lending may be higher or lower. Correcting these three distortions requires a package of three regulations.
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FT50 A*
We propose a tractable model of asset management in which benchmarking arises endogenously, and analyze its welfare consequences. Fund managers' portfolios are not contractible and they incur private costs in running them. Incentive contracts for fund managers create a pecuniary externality through their effect on asset prices. Benchmarking inflates asset prices and creates crowded trades. The crowding reduces the effectiveness of benchmarking in incentive contracts for others, which fund investors fail to account for. A social planner, recognizing the crowding, opts for contracts with less benchmarking and less incentive provision. The planner also delivers lower asset management costs.
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FT50 UTD24 A*
We argue that the pervasive practice of evaluating portfolio managers relative to a benchmark has real effects. Benchmarking generates additional, inelastic demand for assets inside the benchmark. This leads to a “benchmark inclusion subsidy:” a firm inside the benchmark values an investment project more than the one outside. The same wedge arises for valuing M&A, spinoffs, and IPOs. This overturns the proposition that an investment’s value is independent of the entity considering it. We describe the characteristics that determine the subsidy, quantify its size (which could be large), and identify empirical work supporting our model’s predictions.
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American Economic Review
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AER-2023
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- AER-2023-04 (1)
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Journal of Finance
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Journal of Political Economy
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Review of Financial Studies
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