Contagious Bank Runs and Buyer of Last Resort, (joint with Kebin Ma) [view paper] In a crisis, central banks and private investors can find it difficult, if not impossible, to tell whether banks facing runs are insolvent or merely illiquid. In a global-games framework, we show that the lack of information leads to distressed asset prices and restricts central banks' ability to act as a lender of last resort. Under aggregate uncertainty, financial contagion and price volatility emerge as multiple-equilibria phenomena despite global-games refinements. We explain how a central bank can use a buyer-of-last-resort policy to contain contagion and stabilize asset prices while breaking even ex ante---even without information on individual banks' solvency. Bank Information Sharing and Liquidity Risk (joint with Fabio Castiglionesi, and Kebin Ma) [view paper] We propose a novel rationale for the existence of bank information sharing schemes. Banks may voluntarily disclose borrowers' credit history to maintain asset market liquidity. By sharing such information, banks mitigate adverse selection when selling their loans in secondary markets. This reduces the cost of asset liquidation in case of liquidity shocks. Information sharing arises endogenously when the liquidity benefit dominates the cost of losing market power in the primary loan market competition. We show banks having incentives to truthfully disclose borrowers' credit history, even if such information is non-verifiable. We also provide a rationale for promoting public credit registries.
Bank Lending Under Policy Uncertainty: Theory and Cross-Country Evidence (jointwith Di Gong, Tao Jiang and Weixing Wu) [view paper] This paper provides comprehensive theoretical and empirical analyses on bank lending under uncertainty. Our theory differentiates uncertainty from risk and shows that uncertainty-averse banks demand a premium in loan contracting for their exposure to the uncertainty. This premium gets larger as the uncertainty soars. To test our theoretical prediction, we construct a cross-country sample of syndicated loan contracts in 19 major economies over 2000-2015 and proxy the uncertainty with the Economic Policy Uncertainty Index for the same objects and time span. Evidence confirms our theory: A positive relationship between loan spreads and the level of uncertainty is identified. The result is collaborated by an IV estimation with the inverse distance weighted EPU as an instrument.
Unintended Consequences of the Net Stable Funding Ratio Requirement (joint with Kebin Ma) [draft available upon request] We present a dynamic global-games model with the interaction between banks' asset sale and creditor runs. In this general equilibrium framework, we analyze the effects of a Net Stable Funding Ratio requirement on banks' risk of failure and risk of contagion. Our main results are: First, an increase in stable funding will depress bank's asset price, and has unintended consequence on bank's risk of failure. Second, an increase in stable funding leads to an unambiguous increase in bank's risk of contagion. A NSFR requirement neglecting the endogenous feature of bank's asset liquidity is subject to the classic Lucas Critique.
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) [draft available upon request] 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 The Scale of Banks and Internal Risk Management (Joint with Kebin Ma and Lucy White)
