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Journal Article
The role of financial reporting and transparency in corporate governance
The authors review recent literature on the role of corporate financial reporting and transparency in reducing governance-related agency conflicts between managers, directors, shareholders, and other stakeholders?most notably financial regulators?and suggest some avenues for future research. Key themes include the endogenous nature of governance mechanisms with respect to information asymmetry between contracting parties, the heterogeneous nature of the informational demands of contracting parties, and the corresponding heterogeneity of the associated governance mechanisms. The authors also ...
Working Paper
Imperfect Information Transmission from Banks to Investors: Macroeconomic Implications
We study the interaction of information production in loan-backed asset markets and credit allocation in a general equilibrium framework. Originating banks can screen their borrowers, but can inform investors of their asset type only through an error-prone rating technology. The premium paid on highly rated assets emerges as the main determinant of screening effort. Because the rating technology is imperfect, this premium is insufficient to induce the efficient level of screening. However, the fact that banks know their asset quality and produce ratings accordingly helps keep the premium ...
Working Paper
Flight to What? — Dissecting Liquidity Shortages in the Financial Crisis
We endogenize the liquidity and the quality of private assets in a tractable incomplete-market model with heterogeneous agents. The model decomposes the convenience yield of government bond into a "liquidity premium" (flight to liquidity) and a "safety premium" (flight to quality) over the business cycle. When calibrated to match the U.S. aggregate output fluctuations and bond premiums, the model reveals that a sharp reduction in the quality, instead of the liquidity, of private assets was the culprit of the recent financial crisis, consistent with the perception that it was the subprime ...
Working Paper
Imperfect Information Transmission from Banks to Investors: Macroeconomic Implications
Our goal is to elucidate the interaction of banks' screening effort and strategic information production in loan-backed asset markets using a general equilibrium framework. Asset quality is unobserved by investors, but banks may purchase error-prone ratings. The premium paid on highly rated assets emerges as the main determinant of banks' screening effort. The fact that rating strategies reflect banks' private information about asset quality helps keep this premium high. Conventional regulatory policies interfere with this decision margin, thereby reducing signaling value of high ratings and ...
Working Paper
Information Externalities, Funding Liquidity, and Fire Sales
We develop a theory of learning in a model of fire sales and collateralized debt to study how beliefs about fundamentals are shaped by market conditions. Agents exchange short-term debt contracts to invest in a long-term risky asset, and receive shocks to the opportunity cost of funds (cost shocks) and news about the fundamental of the asset, both of which are private information. Asset prices play a dual role of clearing markets and conveying agents' private information, but markets are informationally inefficient: Agents can partially, but never fully, infer their counterparties' private ...
Working Paper
Machines vs. Machines: High Frequency Trading and Hard Information
In today's markets where high frequency traders (HFTs) act as both liquidity providers and takers, I argue that information asymmetry induced by liquidity-taking HFTs' use of machine-readable information is important. This particular type of information asymmetry arises because some machines may access the information before other machines or because of randomness in relative speed. Applying a novel statistical approach to measure HFT activity through limit order book data and using a natural experiment of index inclusion, I show that liquidity-providing HFTs supply less liquidity to stocks ...
Working Paper
Information Externalities, Funding Liquidity, and Fire Sales
We develop a theory of learning in a model of fire sales and collateralized debt to study how beliefs about fundamentals are shaped by market conditions. Agents exchange short-term debt contracts to invest in a long-term risky asset, and receive shocks to the opportunity cost of funds (cost shocks) and news about the fundamental of the asset, both of which are private information. Asset prices play a dual role of clearing markets and conveying agents' private information, but markets are informationally inefficient: Agents can partially, but never fully, infer their counterparties' private ...
Working Paper
Global Banking and Firm Financing: A Double Adverse Selection Channel of International Transmission
This paper proposes a "double adverse selection channel" of international transmission. It shows, theoretically and empirically, that financial systems with both global and local banks exhibit double adverse selection in credit allocation across firms. Global (local) banks have a comparative advantage in extracting information on global (local) risk, and this double information asymmetry creates a segmented credit market where each bank lends to the worst firms in terms of the unobserved risk factor. Given a bank funding (e.g., monetary policy) shock, double adverse selection affects firm ...
Working Paper
Information, Contract Design, and Unsecured Credit Supply: Evidence from Credit Card Mailings
How do lenders of unsecured credit use screening and contract design to mitigate the risks of information asymmetry and limited commitment in the absence of collateral? To address this question, we take advantage of a unique dataset of over 200,000 credit card mail solicitations to a representative sample of households over the recent credit cycle--a period that includes the implementation of the CARD Act. We find that while lenders use credit scores as a prominent screening device, they also take into account a wide array of other information on borrowers' credit histories and financial and ...