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Research

Working Papers

Limits to Bank Deposit Market Power with Erik Stafford  

Claims about the market power of bank deposits in the banking literature are numerous and far reaching. Recently, a causal narrative has emerged in the banking literature: market power in bank deposits, measured as imperfect pass-through of short-term market rates on deposit rates, allows banks to eliminate their asset interest rate exposure and to achieve near constant net interest margin (NIM). We show that the empirical evidence does not support these conclusions. We show that neither deposits nor market power are essential for achieving stable NIM in long-short fixed income portfolios. We show that matching interest income and interest expenses sensitivities to  market rate movements is a consequence of achieving stable NIM, not necessarily the mechanism that allows it. Stable NIM does  not imply near zero interest rate risk according to standard risk measures. Common measures of imperfect pass-through of market rates to bank deposit rates commingle two distinct mechanisms: (1) intentional rate setting and (2) mechanical consequence of comparing the changes in the periodic interest earned on positive maturity fixed coupon portfolios to changes in a short-term interest rate. The mechanical maturity consequence dominates the measured imperfect pass-through of market rates on  time deposits.

How do private equity fees vary across public pensions? (joint with Emil Siriwardane
Under Revision for the Journal of Finance (New Draft March 2022) (Internet Appendix)  
An Empirical Guide to Investor-Level Private Equity Data from Preqin

We study how investment fees vary within private-capital funds. Net-of-fee return clustering suggests that most funds have two tiers of fees, and we decompose differences across tiers into both management and performance-based fees. Managers of venture capital funds and those in high demand are less likely to use multiple fee schedules. Some investors consistently pay lower fees relative to others within their funds. Investor size, experience, and past performance explain some but not all of this effect, suggesting that unobserved traits like negotiation skill or bargaining power materially impact the fees that investors pay to access private markets.

Unpacking the Rise of Alternatives (joint with Pauline Liang and Emil Siriwardane)  

We document a large and heterogeneous shift by public pensions into alternative investments (hedge funds, private equity, and real estate) since 2006. Interpreting the data through the lens of the two-fund separation theorem we find that pensions' attitude towards taking risk cannot account for the size and heterogeneity of the shift. Pension characteristics like size and underfunding explain almost none of the cross-sectional heterogeneity in the shift to alternatives but some of the shift out of fixed income. In contrast, our results are consistent with a sizable shift in beliefs changing the composition of the risky portfolio. Consistent with this hypothesis, a simple variance decomposition shows that investment consultants explain nearly 25% of the variation of which pensions shifts into alternatives. After controlling for consultants, we also document evidence of peer effects in the sense that pensions are more likely to invest in alternatives if their neighbors do.

Do Banks have an Edge? with Erik Stafford  (Slides)

Overall, no! We show that the level and time series variation in cash flows for most bank activities are well matched by capital market portfolios with similar interest rate and credit risk to what banks report to hold. Ignoring operating expenses, bank loans earn high returns and transaction deposits pay low interest rates, consistent with these activities having a potential edge. The edge among these activities is insufficient to cover the large operating expenses of banks. A large portion of the aggregate US banking sector closely resembles a tax inefficient passive mutual fund. The residual risks of bank activities, presumably generated by the unique components of the bank business model, generate systematic risks that are uncompensated.

A Q-Theory of Banks with Saki Bigio and Jeremy Majerovitz and Matias Vieyra (Slides)
Under Revision for the Review of Economic Studies

We propose a dynamic bank theory with a delayed loss recognition mechanism and a regulatory capital constraint at its core. The estimated model matches four facts about banks' Tobin's Q that summarize bank leverage dynamics. (1) Book and market equity values diverge, especially during crises; (2) Tobin's Q predicts future bank profitability; (3) neither book nor market leverage constraints are binding for most banks; (4) bank leverage and Tobin's Q are mean reverting but highly persistent. We examine a counterfactual experiment where different accounting rules produce a novel policy tradeoff.

Banks' Risk Exposure with Monika Piazzesi and Martin K. Schneider
Under revision for Econometrica

This paper studies U.S. banks’ exposure to interest rate and credit risk. We exploit the factor structure in interest rates to represent many bank positions in terms of simple factor portfolios. This approach delivers time varying measures of exposure that are comparable across banks as well as across the business segments of an individual bank. We also propose a strategy to estimate exposure due to interest rate derivatives from regulatory data on notional and fair values together with the history of interest rates. We use the approach to document stylized facts about the recent evolution of bank risk taking.


Work in Progress

What explains fee dispersion in private equity? (joint with Claudia Robles-Garcia and Emil Siriwardane)


Publications

Financial Regulation in a Quantitative Model of the Modern Banking System with Tim Landvoigt  (Slides) (Online Appendix) (Code) 
WFA Award for the Best Paper on Financial Institutions
Forthcoming at the Review of Economic Studies

How does the shadow banking system respond to changes in capital regulation of commercial banks? We propose a quantitative general equilibrium model with regulated and unregulated banks to study the unintended consequences of regulation. Tighter capital requirements for regulated banks cause higher liquidity premia, leading to higher shadow bank leverage and a larger shadow banking sector. At the same time, tighter regulation eliminates implicit subsidies to regulated banks and improves the competitive position of shadow banks, reducing their incentives for risk taking.  The net effect is a safer financial system with more shadow banking. Calibrating the model to data on financial institutions in the U.S., the optimal capital requirement is around 16%.

Firm Selection and Corporate Cash Holdings with Berardino Palazzo
Journal of Financial Economics, Volume 139, Issue 3, March 2021, Pages 697-718

Editor's Choice

Among stock market entrants, more firms over time are R&D–intensive with initially lower profitability but higher growth potential. This sample-selection effect determines the secular trend in U.S. public firms’ cash holdings. A stylized firm industry model allows us to analyze two competing changes to the selection mechanism: a change in industry composition and a shift toward less profitable R&D–firms. The latter is key to generating higher cash ratios at IPO, necessary for the secular increase, whereas the former mechanism amplifies this effect. The data confirm the prominent role played by selection, and corroborate the model’s predictions.

Capital Requirements, Risk Choice, and Liquidity Provision in a Business Cycle Model 
Journal of Financial Economics, Volume 136, Issue 32, May 2020, Pages 355-378
  

This paper develops a quantitative dynamic general equilibrium model in which households’ preferences for safe and liquid assets constitute a violation of Modigliani and Miller. I show that the scarcity of these coveted assets created by increased bank capital requirements can reduce overall bank funding costs and increase bank lending. I quantify this mechanism in a two-sector business cycle model featuring a banking sector that provides liquidity and has excessive risk-taking incentives. Under reasonable parametrizations, the marginal benefit of higher capital requirements related to this channel significantly exceeds the marginal cost, indicating that US capital requirements have been sub-optimally low.

Firm Financing Over the Business Cycle with Juliana Salomao   
The Review of Financial Studies, Volume 32, Issue 4, 1 April 2019, Pages 1235–1274
Lead Article

We study the investment and financing policies of public U.S. firms. Large firms substitute between debt- and equity financing over the business cycle whereas small firms' financing policy for debt and equity is pro-cyclical. This paper proposes a novel mechanism that explains these cyclical patterns in a quantitative heterogeneous firm industry model with endogenous firm dynamics. We find that cross-sectional differences in investment policies and therefore funding needs as well as exposure to financial frictions are key to understand how firms' financing policies respond to macroeconomic shocks. Financial frictions cause firms to be larger with lower valuations and less investments.

Big Data in Finance and the Growth of Large Firms with Maryam Farboodi and Laura Veldkamp
Journal of Monetary Economics. Volume 97, 2018, pp. 71-87

Two modern economic trends are the increase in firm size and advances in information technology. We explore the hypothesis that big data disproportionately benefits big firms. Because they have more economic activity and a longer firm history, large firms have produced more data. As processor speed rises, abundant data attracts more financial analysis. Data analysis improves investors' forecasts and reduces equity uncertainty, reducing the firm's cost of capital. When investors can process more data, large firm investment costs fall by more, enabling large firms to grow larger. 

Remapping the Flow of Funds, with Monika Piazzesi and Martin K. Schneider
Chapter in NBER book Risk Topography: Systemic Risk and Macro Modeling (2014), Markus Brunnermeier and Arvind Krishnamurthy, editors (p. 57-64
)

The Flow of Funds Accounts are a crucial data source on credit market positions in the U.S. economy. In particular, they combine regulatory data from various sources to produce a consistent set of flow and stock tables in major credit market instruments by sector. The events of the last five years have underscored the importance of positions data to guide economic analysis. Viewing positions as payment streams typically requires more information than book value or fair value. However, much of this information is already contained in the data sets from which the Flow of Funds accounts are constructed. This chapter first argues that quantitative analysis of credit market positions would benefit tremendously if the additional information about the structure of payment streams were more readily available, and derives some concrete alternatives for data collection.

Comment: Government Guarantees and the Valuation of American Banks by Andrew G. Atkeson, Adrien d'Avernas, Andrea Eisfeldt, Pierre-Olivier Weill. Prepared for the NBER Macroeconomics Annual 2018, volume 33, Martin Eichenbaum and Jonathan A. Parker, editors