A Theory of Endogenous Asset Fire Sales, Bank Runs, and Contagion (Submitted), (joint with Kebin Ma) [view paper] In a global-games framework, we endogenize asset fire sales, bank runs, and contagion by emphasizing a lack of information: investors can be uncertain whether banks selling assets to fend off runs are insolvent or simply illiquid. However, it is this uncertainty that leads to asset price collapses and runs in the first place. We show that a balanced-budget asset purchase program promotes financial stability by breaking down this vicious cycle. By contrast, increasing capital can exacerbate fire sales in the presence of adverse selection, because runs on well-capitalized banks signal high risks. We also derive implications regarding regulatory disclosure policies. Bank Information Sharing and Liquidity Risk (joint with Fabio Castiglionesi, and Kebin Ma) [view paper] This paper proposes a novel rationale for the existence of information sharing. We suggest that information sharing arises because of banks' need for market liquidity. Banks can reduce their funding liquidity risk by entering in information sharing schemes because, in case of liquidity needs,they will face less adverse selection in the secondary market in which assets are sold. This reduces the costs of assets' liquidation. Such benefit however has to be traded off with the higher competition on the loan market, and the corresponding lower profits. Information sharing can arise endogenously as banks trade off between asset liquidity and rent extraction. We also relax the common assumption in the literature by allowing borrowers' credit history to be non-verifiable, and show that banks still have incentives to truthfully disclose such information in competitive credit markets. CEO Compensation Design in a Multiplicative Model [view paper] We analyze the design of compensation contracts to motivate a risk neutral CEO's effort of developing risky project opportunity, then to induce his best project choice for the firm. Restricted stock induces the CEO to select the project that maximizes the firm's expected value while stock options are superior in incenting the managerial effort. When the risky project has sufficient "upside" value than the firm's existing safe project, it is optimal to pay the CEO solely in restricted stock. Otherwise, the firm faces a trade-off between motivating the CEO's effort and mitigating his excessive risk taking. The second best contract is a combination of restricted stock and stock options. We extend the model to consider a competitive CEO market and find out that there could be circumstances where larger firms hire lower ability CEOs in the market equilibrium. Debt Maturities, Liquidity Risk and Macro-prudential Regulation (joint with Zhili Cao) We consider a model where banks choose their debt maturity structure by weighting short term against long term debt. When using short term debt, banks' refinancing need is triggered by an exogenous macro productivity shock. At the competitive equilibrium: 1. the probability of liquidity crisis, 2. the expected excess refinancing cost, 3. bank's profit, decrease with the probability of experiencing the macro shock. While using long term debt, banks do not need to refinance, yet, they may misbehave due to a lack of interim discipline. The equilibrium borrowing contract should rule out banks' misbehavior, which limits banks' lending capacity. Banks choose short term maturity when they expect a macro shock to occur with a small probability. From a social perspective, the externalities caused by over borrowing in short term debt exist only in the case that the probability of macro shock is large, otherwise, the social optimum coincides with the market equilibrium. Our result points out externality correction tool may only be needed when the probability of macro shock is large. This suggests regulators themselves should be ‘prudential’ on implementing liquidity regulations.
Works in Progress
"Double Bank Runs"(joint with Xavier Freixas, and Kebin Ma) "Bank Corporate Governance and Systemic Risk"
