The Good, the Bad and the Missed Boom
joint with Enrico Perotti
Some credit booms result in financial crises. While excessive risk taking is a plausible cause, many investors do not anticipate increasing risk. We show that credit booms may be misunderstood as productivity-driven, due to opaque bank assets which disguise risk incentives. Balanced funding relative to productive prospects can sustain prudent lending (good boom), while funding imbalances may induce high risk exposure and boost asset prices (bad boom), or lead to asset under-pricing and insufficient lending (missed boom). Rational agents drawing inference from prices make mistakes that can amplify the effect of funding imbalances and propagate risk.
Forthcoming at Review of Financial Studies
Forthcoming at Review of Financial Studies
The Political Economy of Prudential Regulation
This paper studies the equilibrium level of prudential regulation in a framework with negative borrowing externalities. A debt limit is implemented by a politician appointed through majoritarian elections. As voting allows borrowers to internalize the externality, equilibrium regulation restores constrained efficiency whenever the politician can commit to enforce it universally. Under selective enforcement, a captured regulator may exempt politically connected borrowers from regulation. Depending on the electoral power of the connected borrowers, the outcome may be an either too lax or too strict policy. The analysis deepens the understanding of the role of political economy factors in affecting equilibrium regulation. Additional results highlight the impact of income inequality on the strictness of the policy.
2020 Best Job Market Paper in Finance Theory
2020 Best Job Market Paper in Finance Theory
Too Levered for Pigou? A Model of Environmental and Financial Regulation
joint with Robin Döttling
We analyze jointly optimal emission taxes and financial regulation in the presence of environmental externalities and financial constraints. If polluters are financially constrained, optimal emission taxes are below the Pigouvian benchmark (equal to the social cost of emissions). This wedge implies that emission taxes alone cannot implement a constrained efficient allocation. Welfare can be improved by complementing emission taxes with leverage regulation, which provides a rationale for considering climate risks in financial regulatory frameworks. Our model highlights that transition and physical risks have opposite implications for how emission taxes interact with financial constraints. When borrowers are exposed to the physical risk of environmental damages the effect of emission taxes on financial constraints can revert because lower emissions increase asset values and financial slack. As a result, the optimal emission tax may be above the Pigouvian benchmark if the impact of physical risk on asset values is sufficiently large.
To Be Bribed or Lobbied: Political Control or Regulation
joint with Enrico Perotti and Marcel Vorage
The form of political governance determines the structure of competition among interest groups. A politician choosing direct control of firm entry can be bribed, while regulating it through requirements makes her prone to lobbying. Direct control offers exclusive benefit to the winning group resulting in competition among bribers, so all rents accrue to the politician. Under regulation some agent cannot be excluded from entry, giving their lobby a competitive advantage. They extract rents at the expense of the politician. If institutional quality is low politician prefers being bribed as she faces a low risk of prosecution. Heterogeneous legal power of citizens may induce unequal competition also under bribing, allowing powerful bribers to share in political rents.
| to_be_bribed_or_lobbied.pdf |
On the Interaction Between Different Bank Liquidity Requirements
joint with Markus Behn and Renzo Corrias
The post-crisis regulatory framework introduced multiple requirements on banks’ capital and liquidity positions, sparking a discussion among policymakers and academics on how the various requirements interact with one another. This article contributes to the discussion on the interaction of different regulatory metrics by empirically examining the interaction between the liquidity coverage ratio (LCR) and the net stable funding ratio (NSFR) for banks in the euro area. The findings suggest that the two liquidity requirements are complementary and constrain different types of banks in different ways, similarly to the risk-based and leverage ratio requirements in the capital framework. This dispels claims that the LCR and the NSFR are redundant and underlines the need for a faithful and consistent implementation of both measures (and the entire Basel III package more broadly) across all major jurisdictions, to maintain a level playing field at the global level and to ensure that the post-crisis regulatory framework delivers on its objectives.
Published in ECB Macroprudential Bulletin October 2019 Issue 9
Published in ECB Macroprudential Bulletin October 2019 Issue 9