Periodic Reporting for period 2 - INFOMAK (Information, Markets, and the Macroeconomy)
Período documentado: 2022-07-01 hasta 2023-12-31
Financial markets play an essential role in allocating an economy’s resources to their most productive use, fostering investment, employment, innovation, and growth. There is substantial evidence, however, that the presence of frictions that prevent the sound functioning of financial markets can expose economies to large fluctuations and hinder long-term growth. A large literature in microfinance explores the interaction between financial market frictions and macroeconomic fluctuations. The state-of-the-art approach, however, has essentially taken a reduced form approach to credit market frictions by assuming that agents cannot promise all future cash flows from their projects to investors; that is, pledgeability is limited. As the recent financial crisis showed, however, financial markets have problems that go beyond limited pledgeability. Informational problems proved significant, both because many of the assets that were central to the crisis were difficult to understand or because they were prone to severe issues of asymmetric information that surfaced once the crisis hit.
Information problems, of course, have been widely studied in economics. There is a large literature that focuses on how markets function, or may fail to do so, in the presence of information asymmetries among market participants. Much of this literature, however, studies informational problems by taking the quality and the complexity of assets as given, with models often cast in static, partial equilibrium settings.
Motivated by this, the objective of this proposal is two-fold. In Part I, the PI plans to develop novel microeconomic frameworks to study how information asymmetries are affected by agents’ actions, such as choosing to design complex assets or to trade in opaque markets.
Furthermore, the PI will complement these findings with an empirical analysis of the determinants of financial asset complexity in the data. In Part II, the PI will embed these newly developed micro frameworks into dynamic, general equilibrium, macro settings to study how information asymmetries, and resulting incentives to invest and trade in markets, fluctuate over the cycle and across economies
Information problems, of course, have been widely studied in economics. There is a large literature that focuses on how markets function, or may fail to do so, in the presence of information asymmetries among market participants. Much of this literature, however, studies informational problems by taking the quality and the complexity of assets as given, with models often cast in static, partial equilibrium settings.
Motivated by this, the objective of this proposal is two-fold. In Part I, the PI plans to develop novel microeconomic frameworks to study how information asymmetries are affected by agents’ actions, such as choosing to design complex assets or to trade in opaque markets.
Furthermore, the PI will complement these findings with an empirical analysis of the determinants of financial asset complexity in the data. In Part II, the PI will embed these newly developed micro frameworks into dynamic, general equilibrium, macro settings to study how information asymmetries, and resulting incentives to invest and trade in markets, fluctuate over the cycle and across economies
Since the beginning of the project until now, the PI has completed two of the PART 1 projects, which resulted in the publication of two papers in top economic journals:
1. "Security Design in Non-Exclusive Markets with Asymmetric Information" (with Vladimir Asriyan) at the Review of Economic Studies in April 2023.
2. "The Good, the Bad, and the Complex: Product Design with Asymmetric Information" (with Vladimir Asriyan and Dana Foarta) at the American Economic Journal: Microeconomics in May 2023.
In the first paper [1], the PI and her team study the problem of a seller (e.g. a bank) who is privately informed about the quality of her asset and wants to exploit gains from trade with uninformed buyers (e.g. investors) by issuing securities backed by her asset cash flows. In their setting, buyers post menus of contracts, but the seller cannot commit to trade with only one buyer, i.e. markets are non-exclusive. This feature is inherent in most financial markets, where agents cannot easily observe nor control the trades done by their counterparties. They show that non-exclusive markets behave very differently from exclusive ones: first, it is never possible to perfectly identify good from bad quality sellers; moreover, mispricing of claims faced by the seller is always greater than in exclusive markets; there is always an equilibrium where all sellers issue the same debt contract priced at average-valuation (senior tranche), and sellers of low-quality assets issue remaining cash flows at low-valuation (junior tranche). They show that while market liquidity can be higher or lower than in exclusive markets, the average quality of originated assets is always lower when markets are non-exclusive. The model’s predictions are consistent with empirical evidence on the issuance and pricing of mortgage-backed securities, and can be used to evaluate recent reforms aimed at enhancing transparency and exclusivity in markets.
In the second paper [2], the PI and her team study the joint determination of product quality and complexity. To do so, they introduce a novel notion of complexity, which affects how difficult it is for an agent to acquire information about product quality (e.g. how costly it is for an investor to learn the fair value of a financial asset). In the model, an agent can accept or reject a product proposed by a designer, who can affect the quality and the complexity of the product. Examples include banks that design financial products that they offer to retail investors, or policymakers who propose policies for approval by voters. They find that complexity is not necessarily a feature of low-quality products. While an increase in alignment between the agent and the designer leads to more complex but better-quality products, higher product demand or lower competition among designers leads to more complex and lower quality products. The findings are used to rationalize the increased complexity of financial products since the early 2000s and in certain regulatory policies.
The PI has also completed a working paper on the role of credit guarantees in improving firm access to liquidity during times of stress, e.g. pandemic. The work is called "Bank vs. Firms: Who Benefits from Credit Guarantees?" and is joint with Alberto Martin (CREI, UPF, BSE), and Sergio Mayordomo (Bank of Spain). In this paper, the team studies the role of public credit guarantees in an economy where entrepreneurial effort is crucial for efficiency but it is not contractible, giving rise to a debt overhang problem. In such an environment, credit guarantees increase efficiency to the extent that they allow firms to reduce their repayment obligations. They show that banks follow a pecking order when allocating guarantees, prioritizing riskier, highly indebted, firms, from whom they can extract more surplus. They show that there would be gains from regulating markets, as a planner would like to tilt the allocation of guarantees towards more productive, safer firms, and would fully pass-through the benefits of guarantees to firms in the form of lower repayments. Their findings help rationalize some of the features of the allocation of the ICO guarantees in Spain following the outbreak of COVID.
With the help of her ERC funding, the PI has consolidated two teams for continuing the research of Projects 2, 4 and 5 of her proposal. First, within Project 2, the PI is studying opaque/non-exclusive credit markets with Jason Donaldson (USC), Naz Koont (PhD Student at Columbia University), and Giorgia Piacentino (USC). This paper aims to explores both empirically and theoretically the importance of (undrawn!) credit lines in improving firms’ access to finance in non-exclusive credit markets. Second, she has started to work on Projects 4 and 5 of her proposal with V. Asriyan, A. Martin and Guillermo Ordoñez (University of Pennsylvania). The team is exploring the interaction between microeconomic frictions and macroeconomic outcomes, with a focus on the interactions between asset/capital specificity and financial constraints.
1. "Security Design in Non-Exclusive Markets with Asymmetric Information" (with Vladimir Asriyan) at the Review of Economic Studies in April 2023.
2. "The Good, the Bad, and the Complex: Product Design with Asymmetric Information" (with Vladimir Asriyan and Dana Foarta) at the American Economic Journal: Microeconomics in May 2023.
In the first paper [1], the PI and her team study the problem of a seller (e.g. a bank) who is privately informed about the quality of her asset and wants to exploit gains from trade with uninformed buyers (e.g. investors) by issuing securities backed by her asset cash flows. In their setting, buyers post menus of contracts, but the seller cannot commit to trade with only one buyer, i.e. markets are non-exclusive. This feature is inherent in most financial markets, where agents cannot easily observe nor control the trades done by their counterparties. They show that non-exclusive markets behave very differently from exclusive ones: first, it is never possible to perfectly identify good from bad quality sellers; moreover, mispricing of claims faced by the seller is always greater than in exclusive markets; there is always an equilibrium where all sellers issue the same debt contract priced at average-valuation (senior tranche), and sellers of low-quality assets issue remaining cash flows at low-valuation (junior tranche). They show that while market liquidity can be higher or lower than in exclusive markets, the average quality of originated assets is always lower when markets are non-exclusive. The model’s predictions are consistent with empirical evidence on the issuance and pricing of mortgage-backed securities, and can be used to evaluate recent reforms aimed at enhancing transparency and exclusivity in markets.
In the second paper [2], the PI and her team study the joint determination of product quality and complexity. To do so, they introduce a novel notion of complexity, which affects how difficult it is for an agent to acquire information about product quality (e.g. how costly it is for an investor to learn the fair value of a financial asset). In the model, an agent can accept or reject a product proposed by a designer, who can affect the quality and the complexity of the product. Examples include banks that design financial products that they offer to retail investors, or policymakers who propose policies for approval by voters. They find that complexity is not necessarily a feature of low-quality products. While an increase in alignment between the agent and the designer leads to more complex but better-quality products, higher product demand or lower competition among designers leads to more complex and lower quality products. The findings are used to rationalize the increased complexity of financial products since the early 2000s and in certain regulatory policies.
The PI has also completed a working paper on the role of credit guarantees in improving firm access to liquidity during times of stress, e.g. pandemic. The work is called "Bank vs. Firms: Who Benefits from Credit Guarantees?" and is joint with Alberto Martin (CREI, UPF, BSE), and Sergio Mayordomo (Bank of Spain). In this paper, the team studies the role of public credit guarantees in an economy where entrepreneurial effort is crucial for efficiency but it is not contractible, giving rise to a debt overhang problem. In such an environment, credit guarantees increase efficiency to the extent that they allow firms to reduce their repayment obligations. They show that banks follow a pecking order when allocating guarantees, prioritizing riskier, highly indebted, firms, from whom they can extract more surplus. They show that there would be gains from regulating markets, as a planner would like to tilt the allocation of guarantees towards more productive, safer firms, and would fully pass-through the benefits of guarantees to firms in the form of lower repayments. Their findings help rationalize some of the features of the allocation of the ICO guarantees in Spain following the outbreak of COVID.
With the help of her ERC funding, the PI has consolidated two teams for continuing the research of Projects 2, 4 and 5 of her proposal. First, within Project 2, the PI is studying opaque/non-exclusive credit markets with Jason Donaldson (USC), Naz Koont (PhD Student at Columbia University), and Giorgia Piacentino (USC). This paper aims to explores both empirically and theoretically the importance of (undrawn!) credit lines in improving firms’ access to finance in non-exclusive credit markets. Second, she has started to work on Projects 4 and 5 of her proposal with V. Asriyan, A. Martin and Guillermo Ordoñez (University of Pennsylvania). The team is exploring the interaction between microeconomic frictions and macroeconomic outcomes, with a focus on the interactions between asset/capital specificity and financial constraints.
The PIs research aims to advance the research frontier in issues related to financial frictions and macroeconomics. She expects to continue working on the above described projects, to disseminate the obtained knowledge, and to publish all of the work in leading economic and finance journals. In particular, the goal is to submit the existing working papers for publication, and to have new working papers that will lead to publications for her other work in progress.