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Working Paper
Mixed Signals: Investment Distortions with Adverse Selection
We study how adverse selection distorts equilibrium investment allocations in a Walrasian credit market with two-sided heterogeneity. Representative investor and partial equilibrium economies are special cases where investment allocations are distorted above perfect information allocations. By contrast, the general setting features a pecuniary externality that leads to trade and investment allocations below perfect information levels. The degree of heterogeneity between informed agents' type governs the direction of the distortion. Moreover, contracts that complete markets dampen the impact ...
Working Paper
A Macroprudential Perspective on the Regulatory Boundaries of U.S. Financial Assets
This paper uses data from the Financial Accounts of the United States to map out the regulatory boundaries of assets held by U.S. financial institutions from a macroprudential perspective. We provide a quantitative measure of the regulatory perimeter—the boundary between the part of the financial sector that is subject to some form of prudential regulatory oversight and that which is not—and show how it has evolved over the past forty years. Additionally, we measure the boundaries between different regulatory agencies and financial institutions that operate within the regulatory perimeter ...
Working Paper
Moldy Lemons and Market Shutdowns
This paper studies competitive market shutdowns due to adverse selection, where sellers post nonexclusive menus of contracts. We first show that the presence of the worst type of agents (moldy lemons) causes markets to fail only if their mass is sufficiently large. We then show that a small mass of moldy lemons can lead to a large cascade of exits when buyers possess outside options. Our results suggest a parsimonious way of generating sudden market shutdowns without relying on institutional details or imposing additional structure on the model. Thus, the simple insights on the properties of ...
Working Paper
A Model of Endogenous Debt Maturity with Heterogeneous Beliefs
This paper studies optimal debt maturity in an economy with repayment enforcement frictions and investors disagree about repayment probabilities. The optimal debt maturity choice is a mix of long- and short-term debt securities. Spreading risky debt claims on cash flows over time allows debt to be priced by investors most willing to hold risk at each point in time, thereby increasing investment and output. By contrast, a single maturity, either all long- or short-term, will be priced by investors less willing to hold risk, which reduces investment and output. The model provides a novel ...
Working Paper
Credit Default Swaps in General Equilibrium: Spillovers, Credit Spreads, and Endogenous Default
This paper highlights two new effects of credit default swap markets (CDS) in a general equilibrium setting. First, when firms' cash flows are correlated, CDSs impact the cost of capital{credit spreads{and investment for all firms, even those that are not CDS reference entities. Second, when firms internalize the credit spread changes, the incentive to issue safe rather than risky bonds is fundamentally altered. Issuing safe debt requires a transfer of profits from good states to bad states to ensure full repayment. Alternatively, issuing risky bonds maximizes profits in good states at the ...