Michael Gofman

Assistant Professor of Finance
Michael Gofman

Research Interests: Financial Networks, Financial Intermediation, Financial Regulation, Production Networks, Trade Credit, Systemic Risk, Financial Stability, Payment Systems, Creative Destruction

Curriculum Vitae

Contact Information:

Simon Business School
University of Rochester
Rochester, NY 14627

INET Financial and Economic Networks Conference that I organized in August 2013

Research papers

Efficiency and Stability of a Financial Architecture with Too-Interconnected-To-Fail Institutions (Journal of Financial Economics)

The regulation of large interconnected financial institutions has become a key policy issue. To improve financial stability, regulators have proposed to limit banks' size and interconnectedness. I estimate a network-based model of the over-the-counter interbank lending market in US and quantify the efficiency-stability implications of this policy. Trading efficiency decreases with limits on interconnectedness because the intermediation chains become longer. While restricting the interconnectedness of banks improves stability, the effect is non-monotonic. Stability also improves with higher liquidity requirements, when banks have access to liquidity during the crisis, and when failed banks' depositors maintain confidence in the banking system.

Consequences of Failure of the Most Interconnected Bank(s)

Production Networks and Stock Returns: The Role of Vertical Creative Destruction with Gill Segal and Youchang Wu (R&R Review of Financial Studies)

We study the relation between firms' risk and their upstreamness in a production network. Empirically, firms' average stock returns and productivity exposures increase monotonically with their upstreamness. We quantitatively explain these novel facts using a multi-layer general equilibrium model. These patterns arise from vertical creative destruction - innovations by suppliers devalue customers’ assets-in-place. We confirm several model predictions, and document additional new facts consistent with vertical creative destruction: a diminished value premium among downstream firms and a negative relation between downstream firms’ returns and their suppliers’ competitiveness. Overall, vertical creative destruction has a sizable effect on cross-sectional risk premia.

Vertical Position and Stock Returns

A Network-Based Analysis of Over-the-Counter Markets (R&R Review of Financial Studies)

I study how intermediation in over-the-counter markets affects their allocational efficiency. Over-the-counter markets are modeled as a trading network in which bilateral prices and trading decisions are jointly determined in equilibrium. Market efficiency depends crucially on the network structure and the split of surplus between traders. The probability that market allocations are always efficient tends to zero in large markets. The expected welfare loss can be substantial and it can increase even if the amount of intermediation decreases. A large interconnected financial institution can improve efficiency. This welfare gain should be considered when deciding whether large financial institutions are too-interconnected-to-exist.

Non-monotonic Relationship between Efficiency and Network Density

Profitability, Trade Credit and Institutional Structure of Production (R&R Journal of Financial Economics)

I develop a methodology to construct a network of supplier-customer relationships for 990 US firms. I compute a measure of vertical position of each firm in a production chain and measure the number of production layers in the economy. The vertical position measures are used to test trade credit theories. The recursive moral hazard theory of trade credit by Kim and Shin (2012) is supported by reduced-form regressions and by estimation of the optimal contract between firms that predicts a positive relationship between firm's vertical position and firm's incentives to produce high quality inputs, measured by profit margins and net trade credit. I also document that the difference in incentive levels between a pair of firms is positively related to their relative position in the supply chain. These results suggest that to understand contracting between firms we need to extend the bilateral analysis to an analysis of the entire production chains.

Institutional Structure of Production in US

Interbank trading, collusion and financial regulation with Dean Corbae

We show theoretically and empirically that interbank markets provide a channel for banks to collude in the market for business loans. By lending funds to a competitor, a bank commits not to compete. Interbank interest rates allow banks to split the benefits from such collusion. Using global syndicated loans data, we find that firms paid 31bps higher spread on $239 billion of loans provided by banks that took an interbank loan from a competitor. We compare the decentralized solution with interbank market to the planner's solution and to the decentralized equilibrium without interbank market. The results suggest that restricting interbank trading may increase aggregate welfare.

Collusion using itnerbank market

High-frequency analysis of financial stability with Sajjad Jafri and James Chapman

We study empirically efficiency and stability trade off in the design of large value payment systems using \$500 trillion CAD of intraday transaction level data from Canadian Large Value Transfer System (LVTS). We develop measures of systemic risk and apply these measures to millions of LVTS payments during 2001-2014. LVTS showed stress during 2007-2009. The main source of fragility of the system are binding collateral and credit constraints that cause delays and rejections of payments. Unprecedented injection of liquidity by the Bank of Canada prevented a spillover of systemic risk to global systemically important payment and settlement systems.

Collusion using itnerbank market

An Empirical Evaluation of the Black-Litterman Approach to Portfolio Choice with Asaf Manela

We evaluate the Black-Litterman equilibrium model approach to portfolio choice. We quantify the improvement in portfolio performance of a privately informed investor who learns from market prices over an equally informed, but dogmatic investor who only uses private information. We extend the approach to any linear multi-factor asset pricing model (e.g. ICAPM) to examine how learning from prices using different equilibrium models affects portfolio performance. We find that even a misspecified asset-pricing model can improve portfolio performance when private signals are not extremely precise. As we increase the noise in private information, learning from prices is initially harmful and gradually becomes more beneficial.

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Teaching Resources

Since March 2014 I have been using Google Glass to provide video feedback to my students on their assignments.

Michael Gofman: Google Glass Usage for Providing Feedback to Students

Watch a 2 min Youtube video: Google Glass Inspires Students and Improves the Learning Experience