Research Interests: Financial Networks, Financial Intermediation, Financial Regulation, Production Networks, Trade Credit, Systemic Risk, Financial Stability, Payment Systems, Creative Destruction
Production Networks and Stock Returns: The Role of Vertical Creative Destruction (with Gill Segal and Youchang Wu )
We study creative destruction in production networks and its implication for firms' risk profiles.
Empirically, upstream firms with the longest distance to consumers earn an excess return of 105 basis points per month relative to downstream consumption producers. We explain this novel spread quantitatively using a general equilibrium model with multiple layers of production. The spread arises endogenously due to vertical creative destruction -- innovations by direct and indirect suppliers devalue the installed capital of customer firms. Consistent with our model predictions, the spread is smaller among firms that belong to supply chains with lower competition, and is larger among firms whose assets-in-place account for a larger fraction of firm value. We document other new facts that can be reconciled via vertical creative destruction: (1) a diminished value premium among downstream firms; (2) a positive relation between the return of downstream firms and the market power of their direct and indirect suppliers. Overall, we explore a novel channel of creative destruction and demonstrate its significant impact on firmsí cost of capital.
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.
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.
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.
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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