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Abstract:
Private information about prospective borrowers produced by a bank can affect rival lenders due to a "winner's curse" effect. Strategic interaction between banks with respect to the intensity of costly information production results in endogenous credit cycles, periodic "credit crunches." Empirical tests are constructed based on parameterizing public information about relative bank performance that is at the root of banks' beliefs about rival banks' behavior. Consistent with the theory, we find that the relative performance of rival banks has predictive power for subsequent lending in the credit card market, where we can identify the main competitors. At the macroeconomic level, we show that the relative bank performance of commercial and industrial loans is an autonomous source of macroeconomic fluctuations. We also find that the relative bank performance is a priced risk factor for both banks and nonfinancial firms. The factor-coefficients for non-financial firms are decreasing with size.

Abstract:
A bank determines whether potential borrowers are credit-worthy, that is, whether they meet the bank's credit or lending standards. In making this determination, each bank is in competition with other banks, but without knowing the competitor banks' credit standards. The resulting unique form of competition leads to endogenous credit cycles, periodic "credit crunches." Empirical tests of this repeated bank lending game are constructed based on parameterizing public information about relative bank performance that is at the root of banks' beliefs about rival banks' lending standards. The relative performance of rival banks has predictive power for subsequent lending in the credit card market, where we can identify the main competitors. At the macroeconomic level, the relative bank performance of commercial and industrial loans is an autonomous source of macroeconomic fluctuations. In an asset pricing context, the relative bank performance is a priced risk factor for both banks and nonfinancial firms. The factor-coefficients for non-financial firms are decreasing with size, consistent with smaller firms being more bank-dependent.

credit cycles, credit crunches

Abstract:
In the IPO market, investors coordinate on acceptable IPO price based on the performance of past IPOs, and this generates an incentive for investment banks to produce information about IPO firms. In hot periods, the information produced by investment banks improves the quality of IPO firms, and this allows ex ante low quality firms to go public and increases the secondary market price, thus synchronizing high IPO volumes and high first day returns. When investment banks behave asymmetrically in information production, the “reputations” of investment banks are interpreted as a form of market segmentation to economize on the social cost of information production.

G24, C73

Abstract:
In the IPO market, investors coordinate on acceptable IPO price based on the performance of past IPOs, and this generates an incentive for investment banks to produce information about IPO firms. In hot periods, the information produced by investment banks improves the quality of IPO firms, and this allows ex-ante low quality firms to go public and increases the secondary market price, thus synchronizing high IPO volumes and high first day returns. When investment banks behave asymmetrically in information production, the reputations of investment banks are interpreted as a form of market segmentation to economize on the social cost of information production.

IPO, Certification, Underpricing, Hot and Cold Market, Reputation

Abstract:
We analyze the interaction between managerial decisions and firm value/asset prices by embedding the standard agency model of the firm into an otherwise standard asset pricing model. When the manager-agent's compensation depends on the firm's stock price performance, stock prices are set to induce the creation of future cash flows, instead of representing the discounted value of exogenous cash flows, as in the standard model. In our case, stock prices are formed via trading in the market to induce the managers to hold the number of shares consistent with the optimal effort level desired by the outside investors. We compare two price formation mechanisms, corresponding to two firm ownership structures. In the first, stock prices are formed competitively among a continuum of dispersed investors. In the second, stock prices are set by a single block shareholder, as a bargaining solution. Under both mechanisms there are persistent, dynamic, patterns of asst prices, The level of the equity premium and the return volatility depend on the risk aversion of the agents in the economy and the ownership structure of firms.

Abstract:
Entrenched managers can be disciplined by stock prices in a limited way. When a manager cannot be perfectly controlled via optimal contracting, the canonical asset pricing model must be integrated with corporate finance to produce a pricing kernel which simultaneously discounts the firm's cash flows and sets incentives for the risk averse manager to produce those same cash flows. In equilibrium the stock price is set to provide an incentive, via managerial shareholdings, for the manager to make an effort to produce the cash flows. This is complicated by risk sharing considerations. In this context, we study the equity premium, the excess volatility of equity returns, and share price dynamics. We study two polar cases of outside share ownership: completely dispersed shareholders and a single blockholder. We also propose a Markovian equilibrium concept that enables us to use dynamic programming in both of these settings.

Agency Problem, Corporate Governance, Asset Pricing, Price Formation

Abstract:
We study the "efficient markets" paradigm in the context of agency relations: principal-investors want to monitor and compensate their agent-traders using market security prices in "mark-to-market" contracts. The view of each principal is that market prices aggregate the information from other market participants so they can be used to monitor agent-traders. If the market is dominated by such delegated traders, then these traders can attempt to manipulate the market price by shirking jointly and buying or selling in the same direction. In this way, traders provide market "proof" that they have worked hard and deserve high compensation. We show that markets dominated by delegated traders are less efficient than other markets. The extent of "market efficiency," indexed by the delegated traders' propensity of joint shirking, is endogenized.

agency problem, mark to market, market efficiency

Abstract:
Individuals tend to simplify a complex portfolio decision problem into several manageable dimensions, each of which can frame their perception of risk in a certain way. We check this view by studying the effect of investment horizon on households' portfolio decisions. Using the Federal Reserve Board's Survey of Consumer Finances (SCF) data, we find that households allocate more of their wealth in stocks if they report longer planning horizons, and we find that the existence of foreseeable expenditure significantly change the dependence of risky stock investment on the planning horizon. We decompose the reported planning horizon into an objective part and a subjective mental accounting part, and find that the mental accounting part has a greater effect on household portfolio choice. This is consistent with the argument that individuals make investment decision based on the horizon at which the risk is perceived rather than the horizon at which the investment is made.

Mental Accounting, Time Diversification, Planning Horizon

Abstract:
We show how to estimate affine term structure models from a panel of noisy bond yields using simulated maximum likelihood based on importance sampling. We approximate the likelihood function of the state-space representation of the model by correcting the likelihood function of a Gaussian first-order approximation for the non-normalities introduced by the affine factor dynamics. Depending on the accuracy of the correction, which is computed through simulations, the quality of the estimator ranges from quasi-maximum likelihood (no correction) to exact maximum likelihood as the simulation size grows.

Term Structure, State-Space Representation, Importance Sampling, Simulated Likelihood

Abstract:
One important function of banks is to issue liabilities, like demand deposits, that are relatively safe and also liquid (usable as means of payment). We introduce risk of theft and a safe-keeping role for banks into monetary theory. This provides a general equilibrium framework for analyzing banking in historical and contemporary contexts. The model can generate concurrent circulation of cash and bank liabilities as media of exchange (inside and outside money), and yields novel policy implications. For example, negative nominal interest rates are feasible, and for some parameters optimal; for other parameters, strictly positive rates (inflation above the Friedman Rule) are optimal.

Money, Banking, Liquidity, Inflation, Monetary Policy

Abstract:
Risk management in securities markets refers to the oversight of portfolio managers and professional traders when they trade on behalf of investors in security markets. Monitoring of their trading performance, profit and loss, and risk-taking behavior, is measured by principals using security market prices. We study the optimality of the practice of marking-to-market and provide conditions under which investing principals should optimally monitor their agent traders using market prices to measure traders' performance. Asset prices, however, can be affected by mark-to-market contracts. We show that such contracts introduce an externality when there are many traders. Traders may rationally herd, trading on irrelevant information. Ironically, this causes asset prices to be less informative than they would be without the mark-to-market feature.

Abstract:
We develop a new theory of money and banking based on the old story in which goldsmiths start accepting deposits for safe keeping, then their liabilities begin circulating as media of exchange, then they begin making loans. We first discuss the history. We then present a model where agents can open bank accounts and write checks. The equilibrium means of payment may be cash, checks, or both. Sometimes multiple equilibria exist. Introducing banks increases the set of parameters for which money is valued - thus, money and banking are complements. We also derive a microfounded version of the usual money multiplier.

Abstract:
Does government control reduce firm value? A strong government control helps the government to extract social or political benefits from a state-controlled firm, thus decreases its value; but it also makes it more effective for the government to monitor the firm management, thus increases its value. We first formally analyze these two effects and their interactions in a theoretic model of IPO. We then use the data of state-controlled listed firms in China to study the impact of government control on firm performance empirically. The strength of government control is measured by the length of the intermediate ownership chain between listed firms and their ultimate controllers, defined as "layer". Consistent with the theory predictions, we find that there exists an optimal layer at which the firm value is maximized, but the government chooses a shorter layer than the optimal level. We also find that firms with good corporate governance, as a substitution for government monitoring, has a higher optimal layer and is more efficient.

Government Control, State-Owned Firms, Agency Problem, Corporate Governance

Abstract:
The controlling shareholder of a firm may suffer from its control of the firm due to unfavorable market reactions associated with concerns on his private benefit extraction. Thus, the controlling shareholder has an incentive to build a good governance mechanism as a commitment device to discipline himself, which allows him to sell shares at a higher price in the initial public offering (IPO). An improvement in IPO pricing efficiency will give the controlling shareholder more incentive to do so. Therefore, we propose that, the development of the financial market can shape the corporate governance of firms in an economy, thus improving firm operation efficiency. A model of IPO is constructed to demonstrate this mechanism of market discipline. Using data from China stock market on the regulatory changes in IPO pricing and firm ownership structure, we find evidence consistent with the model's implications.

Financial market development, Ownership structure, Market discipline, Pricing efficiency, Initial public offering