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Working Paper
Measuring Transaction Costs in the Absence of Timestamps
This paper develops measures of transaction costs in the absence of transaction timestamps and information about who initiates transactions, which are data limitations that often arise in studies of over-the-counter markets. I propose new measures of the effective spread and study the performance of all estimators analytically, in simulations, and present an empirical illustration with small-cap stocks for the 2005-2014 period. My theoretical, simulation, and empirical results provide new insights into measuring transaction costs and may help guide future empirical work.
Working Paper
When do low-frequency measures really measure transaction costs?
We compare popular measures of transaction costs based on daily data with their high-frequency data-based counterparts. We find that for U.S. equities and major foreign exchange rates, (i) the measures based on daily data are highly upward biased and imprecise; (ii) the bias is a function of volatility; and (iii) it is primarily volatility that drives the dynamics of these liquidity proxies both in the cross section as well as over time. We corroborate our results in carefully designed simulations and show that such distortions arise when the true transaction costs are small relative to ...
Working Paper
Banks as Regulated Traders
This paper uses detailed high-frequency regulatory data to evaluate whether trading increases or decreases systemic risk in the U.S. banking sector. We estimate the sensitivity of weekly bank trading net profits to a variety of aggregate risk factors, which include equities, fixed-income, derivatives, foreign exchange, and commodities. We find that U.S. banks had large trading exposures to equity market risk before the introduction of the Volcker Rule in 2014 and that they curtailed these exposures afterwards. Pre-rule equity risk exposures were large across the board of the main asset ...
Working Paper
Identifying Contagion in a Banking Network
We present the first micro-level evidence of the transmission of shocks through financial networks. Using the network of credit default swap (CDS) transactions between banks, we identify bank CDS returns attributable to counterparty losses. A bank's own CDS spread increases whenever counterparties from whom it has purchased default protection themselves experience losses. We find no such effect from losses of non-counterparties, nor from counterparties to whom the bank has sold protection. The effect on bank CDS returns through this counterparty loss channel is large relative to the direct ...
Working Paper
The Evolution of Price Discovery in an Electronic Market
We study the evolution of the price discovery process in the euro-dollar and dollar-yen currency pairs over a ten-year period on the EBS platform, a global trading venue used by both manual and automated traders. We find that the importance of market orders decreases sharply over that period, owing mainly to a decline in the information share from manual trading, while the information share of market orders from algorithmic and high-frequency traders remains fairly constant. At the same time, there is a substantial, but gradual, increase in the information share of limit orders. Price ...
Working Paper
Banks as Regulated Traders
Banks use trading as a vehicle to take risk. Using unique high-frequency regulatory data, we estimate the sensitivity of weekly bank trading profits to aggregate equity, fixed-income, credit, currency and commodity risk factors. Our estimates imply that U.S. banks had large trading exposures to equity market risk before the Volcker Rule, which they curtailed afterwards. They also have exposures to credit and currency risk. The results hold up in a quasi-natural experimental design that exploits the phased-in introduction of reporting requirements to address identification. Heterogeneity and ...
Working Paper
Liquidity Provision and Co-insurance in Bank Syndicates
We study the capacity of the banking system to provide liquidity to the corporate sector in times of stress and how changes in this capacity affect corporate liquidity management. We show that the contractual arrangements among banks in loan syndicates co-insure liquidity risks of credit line drawdowns and generate a network of interbank exposures. We develop a simple model and simulate the liquidity and insurance capacity of the banking network. We find that the liquidity capacity of large banks has significantly increased following the introduction of liquidity regulation, and that the ...
Discussion Paper
Household and Business Debt: A Fire-Sale Risk Analysis
As of year-end 2019, nonfinancial business debt (BD) and household debt (HD) as a share of GDP were at similar levels of around 74 percent, and yet Federal Reserve Financial Stability Report suggested that BD posed greater risks to financial stability than HD. Since the onset of the pandemic, the size of aggregate BD has increased considerably as a result of roughly $1.25 trillion of new issuance, while HD has grown by less than $100 billion. This note looks through the lens of fire-sale risks to show why nonfinancial BD is more concerning for financial stability than the HD.