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Working Paper
Market run-ups, market freezes, inventories, and leverage
This paper supersedes Working Paper No. 12-8.> We study trade between an informed seller and an uninformed buyer who have existing inventories of assets similar to those being traded. We show that these inventories may lead to prices that increase even absent changes in fundamentals (a .run-up.), but may also make trade impossible (a .freeze.) and hamper information dissemination. Competition may amplify the run-up by inducing buyers to enter loss-making trades at high prices to prevent a competitor from purchasing at a lower price and releasing bad news about inventory values. Inventories ...
Working Paper
Financial networks: contagion, commitment, and private sector bailouts
The author develops a model of financial networks where linkages not only spread contagion, but also induce private-sector bailouts in which liquid banks bail out illiquid banks because of the threat of contagion. Introducing this bailout possibility, the author shows that linkages may be optimal ex-ante because they allow banks to obtain some mutual insurance even though formal commitments are impossible. However, in some cases (for example, when liquidity is concentrated among a small group of banks), the whole network may collapse. The author also characterizes the optimal network size and ...
Working Paper
Market run-ups, market freezes, and leverage
The authors study trade between a buyer and a seller when both may have existing inventories of assets similar to those being traded. They analyze how these inventories affect trade, information dissemination, and price formation. The authors show that when the buyer's and seller's initial leverage is moderate, inventories increase price and trade volume, but when leverage is high, trade may become impossible (a "market freeze"). Their analysis predicts a pattern of trade in which prices and trade volume first increase, and then markets break down. The authors use their model to discuss ...
Working Paper
A theory of an intermediary with nonexclusive contracting
This paper addresses large markets where agents cannot commit to sign exclusive contracts may induce agents to promise the same asset to multiple counterparties and subsequently default. Is how that in such markets an intermediary can increase welfare by simply setting limits on the number of contracts that agents can report to it voluntarily. In some cases, these limits must be nonbinding in equilibrium, and reported trades must not be made public. The theory shows why an exchange may be valuable even when markets are liquid. It also suggests why in some cases a regulator should not reveal ...
Journal Article
Why do markets freeze?
In normal times, investors buy and sell financial assets because there are gains from trade. However, markets do not always function properly ? they sometimes ?freeze.? An example is the collapse of trading in mortgage-backed securities during the recent financial crisis. Why does trade break down despite the potential gains from trade? Can the government intervene to restore the normal functioning of markets? In ?Why Do Markets Freeze?,? Yaron Leitner explains what a market freeze is and some of the theories as to why these freezes occur.
Journal Article
Stock prices and business investment
Is there a link between the stock market and business investment? Empirical evidence indicates that there is. A firm tends to invest more when its stock price increases, and it tends to invest less when the price falls. In ?Stock Prices and Business Investment,? Yaron Leitner discusses existing research that explains this relationship. One question under consideration is whether the stock market actually improves investment decisions.
Journal Article
Should regulators reveal information about banks?
Regulators collect and produce information about banks. This information helps regulators monitor the safety and soundness of the banking system, and it also helps policymakers preserve financial stability. A key issue is whether this information should be made public and, if so, to what extent. In this article, we will explore some of the tradeoffs involved.
Working Paper
Stress tests and information disclosure
Superseded by Working Paper 15-10. We study an optimal disclosure policy of a regulator who has information about banks? ability to overcome future liquidity shocks. We focus on the following trade-off: Disclosing some information may be necessary to prevent a market breakdown, but disclosing too much information destroys risk-sharing opportunities (Hirshleifer effect). We find that during normal times, no disclosure is optimal, but during bad times, partial disclosure is optimal. We characterize the optimal form of this partial disclosure. We also relate our results to the debate on the ...
Working Paper
Why do markets freeze?
Consider the sale of mortgages by a loan originator to a buyer. As widely noted, such a transaction is subject to a severe adverse selection problem: the originator has a natural information advantage and will attempt to sell only the worst mortgages. However, a second important feature of this transaction has received much less attention: both the seller and the buyer may have existing inventories of mortgages similar to those being sold. The authors analyze how the presence of such inventories affects trade. They use their model to discuss implications for regulatory intervention in ...
Working Paper
REGULATING A MODEL
REVISED: 5/2018: We study a situation in which a regulator relies on models produced by banks in order to regulate them. A bank can generate more than one model and choose which models to reveal to the regulator. The regulator can find out the other models by monitoring the bank, but, in equilibrium, monitoring induces the bank to produce less information. We show that a high level of monitoring is desirable when the bank's private gain from producing more information is either sufficiently high or sufficiently low (e.g., when the bank has a very little or very large amount of debt). When ...