Too-Many-to-Fail and the Design of Bailout Regimes (with Wolf Wagner)

R&R, Review of Financial Studies

We show that the too-many-to-fail problem can be resolved through an appropriate design of the bailout regime. In our model, optimal investment balances benefits from more banks investing in high-return projects against higher systemic costs due to more banks failing simultaneously. Under a standard bailout regime, banks herd, anticipating that simultaneous failures trigger bailouts. However, a policy that prioritizes bailing out a predesignated group of banks eliminates herding and achieves the first-best. If such a policy is not feasible, its benefits can be attained by decentralizing bailout decisions to two regulators each responsible for a separate group of banks.

Voluntary Support and Ring-Fencing in Cross-Border Banks (with Gyoengyi Loranth and Anatoli Segura)

R&R, Management Science

Lamfalussy Fellowship 2020, European Central Bank

We study supervisory interventions in cross-border banks under different institutional architectures in a model in which a bank may provide voluntary support to an impaired subsidiary using resources in a healthy subsidiary. While a supranational architecture permits voluntary support, a national architecture gives rise to inefficient ring-fencing of a healthy subsidiary when there is high correlation between the subsidiaries' assets. The enhanced cross-subsidiary support allowed by a supranational architecture affects banks' risk-taking, leading to a convergence of the subsidiary risk of banks with heterogeneous fundamentals. Finally, the objective to minimize national expected deposit insurance costs is achieved through a supranational architecture for riskier banks, but not so for safer banks even in situations in which it would be aggregate welfare improving.

Subsidiary Financing: Risk-Shifting as a Commitment Device (with Gyoengyi Loranth and Alan Morrison)

R&R, Review of Corporate Finance Studies
Previous title: "Organizational Structure and Investment Strategy"

We study how firms can design their organizational structures to overcome dynamic commitment problems when entering new markets or technologies. A manager exerts costly effort to first develop and subsequently manage an investment opportunity. Ex post, the firm underinvests in projects that generate high management rents. However, the prospect of those rents helps offset the manager’s initial project development cost, making ex ante commitment to invest optimal. Levered subsidiaries mitigate this time-consistency problem by introducing risk-shifting incentives that counteract underinvestment. Subsidiaries are most valuable for projects that are costly to develop, have moderate management costs, and yield returns uncorrelated with existing business.

Market-Based Green Firms (with Konrad Adler, Oliver Rehbein and Matthias Reiner)

[Data/Website]

This paper proposes a simple but effective tool to measure firms' exposure to climate risk: the market. We first develop a model showing that abnormal stock returns around significant climate policy events measure a firm's exposure to climate risk. On this basis, we create market-based firm greenness measures for around 36,000 international firms based on abnormal returns around UN climate conferences. The resulting measure creates intuitive rankings of sector-level climate-risk exposure and is correlated with, but distinct from existing measures. At the firm level, market-based greenness is associated with lower present and future carbon emissions. Green firms are more likely to file green patents, have lower stock-price volatility, and tend to be financially more robust. At the country level, market-based greenness is associated with lower emission intensity and a larger share of renewable energy.

Contingent Capital Structure

Belgrade Young Economists Conference UnitCredit & Universities Best Paper Award 2014

This paper studies the optimal financing contract of a bank with risk-shifting incentives and private information in an environment with macroeconomic uncertainty. Leverage mitigates adverse selection problems owing to debt information-insensitivity but leads to excessive risk-taking. I show that the optimal leverage is procyclical in the laissez-faire equilibrium, and contingent convertible (CoCo) bonds emerge as part of the implementation of the optimal contingent capital structure. However, the equilibrium entails excessive leverage and risk-taking due to a bank's private incentives to minimise market mispricing of its securities. It is socially optimal to impose countercyclical capital requirements, implemented by CoCo bonds in addition to straight debt and equity.