Working Papers

A Macroeconomic Model with Bond Market Liquidity [New Draft!]

Abstract: I study the effects of bond market liquidity on the macroeconomy. I incorporate over-the-counter secondary bond markets with search frictions into a quantitative macroeconomic model. The model links standard measures of bond illiquidity, such as bid-ask spreads and parameters driving bond illiquidity at the microeconomic level, to macroeconomic variables. In the model, firms rollover long-term bonds. A worsening of bond market liquidity lowers prices of long-term bonds and increases firms’ default probability through the rollover channel. Firms borrow working capital loans to pay wage upfront. A higher default probability leads to higher interest rates on working capital loans and thus higher labor cost, and consequently, employment drops. By calibrating the model to match key features of the US economy during the Great Recession, I show that disruptions in bond market liquidity could explain 36% of the labor drop in data. The paper also provides a structural estimate of the impacts of the Fed’s corporate bond purchasing program on the real economy during the COVID-19 crisis. By improving bond market liquidity, the Fed’s interventions avoided a 4.3 percentage point drop in employment.

Bonds vs. Equities: Information for Investment, with Adrien d’Avenas and Andrea L. Eisfeldt [PDF], accepted at the Journal of Finance

Abstract: Why do credit spreads explain firm investment better than equity volatility does? In a standard corporate finance setting, this can be explained as a consequence of credit spreads and asset volatility having unambiguous relationships with investment, while equity volatility sends a mixed signal: Elevated volatility raises the option value of equity and increases investment for financially sound firms, but it exacerbates debt overhang and decreases investment for firms close to default. Overall, our study clarifies the structural and empirical relationships between investment, leverage, credit spreads, volatility, and Tobin’s q.

CBDC and Banks’ Disintermediation in a Portfolio Choice Model, with Lucyna Górnicka, Federico Grinberg, Marcello Miccoli, and Brandon Tan,[PDF] IMF Working Paper

Abstract: Would the introduction of a Central Bank Digital Currency (CBDC) lead to lower deposits (disintermediation) and lending in the banking sector? This paper develops a model where households heterogeneous in wealth allocate between an illiquid asset and assets that can be used for payments: bank deposits, cash, and CBDC. CBDC is more efficient as a means of payment and has lower access cost than deposits. Deposits are offered by an imperfectly competitive banking sector which raises deposit interest rates after CBDC introduction to prevent substitution away from deposits to CBDC. We find that there are two opposing margins of impact on the level of aggregate deposits: (1) the intensive margin gain in deposits by richer households increasing their holdings of deposits because of higher interest rates, and (2) the extensive margin loss of deposits among poorer households who switch from deposits to the CBDC. The extensive margin gain in deposits is more likely to dominate (yielding a fall in total deposits) when the mass of poorer households is large and when it is relatively costly to access bank accounts. This tends to be the case in developing and emerging market economies. However, even when the extensive margin loss of deposits dominates and there is disintermediation, the impact on lending is quantitatively small if banks have access to other forms of funding, such as wholesale or central bank financing.

Work in Progress

Market Liquidity and Bond Issuance: Effects of the Fed’s Interventions during the COVID-19 Crisis, with Shihan Shen