Working Papers

A Macroeconomic Model with Bond Market Liquidity (Job Market Paper) [PDF]

Abstract: Do disruptions in market liquidity of long-term bonds have a quantitatively important impact on the macroeconomy? This paper introduces search-based secondary markets for long-term corporate bonds into a dynamic general equilibrium model. In the model, with borrowing constraints and incomplete insurance, firms restrict hiring ex-ante when default risk increases. Bond market liquidity, by affecting bond prices and thus the borrowing limits for firms, has impacts on firms' labor choices. A positive default-liquidity spiral further amplifies these effects. Using a calibrated model, I show that a liquidity shock that is calibrated to match the observed increase in the bid-ask spread explains about 20% of the employment losses in the Great Recession. 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 2 percentage point drop in employment.

Bonds vs. Equities: Information for Investment, with Adrien d’Avenas and Andrea L. Eisfeldt [PDF], R&R 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, and Marcello Miccoli [Slides][Draft available upon request]

Abstract: Under what circumstances can the introduction of CBDC disintermediate the banking sector? The paper sets up a portfolio choice model as a laboratory to explore this question and finds that only in special cases introducing CBDC reduces bank credit and when it does, the effect is small. In the model, households choose how to allocate their wealth between illiquid and liquid assets (and among which how much cash, bank deposits and CBDC to hold), and an imperfectly competitive banking sector offers deposits and lending. In a simple case in which all liquid assets are equally costless to access, the introduction of a no interest-bearing CBDC does not lead to banking disintermediation, as banks’ increase the return on deposits to fight off the competition from CBDC. However, in the presence of costly access to bank deposits and CBDC, the introduction of the latter may create disintermediation of the banking sector under specific conditions: when CBDC has much lower costs to hold than bank deposits and the wealth distribution is fairly unequal, poorer households will stop holding bank deposits in favor of CBDC, but banks will not aggressively fight to prevent the outflow of customers due to their relatively smaller wealth. This can lead to an aggregate decrease in bank deposits. Still, the impact on lending will be 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