Working papers

Security Design, Informed Intermediation, and the Resolution of Borrowers' Financial Distress (with John Kuong)

• Banks as informed intermediaries have information about their borrowers to make efficient liquidation versus restructuring decisions for distressed loans, but their information also creates an adverse selection problem when they seek financing from uninformed investors. We demonstrate that a bank with high-quality loans faces incentives to distort its resolution policy in order to improve allocative efficiency and to signal information about loan quality, with the direction of the distortion depending on whether the security issued to uninformed investors is concave or convex. We find that the bank's equilibrium resolution policy is biased towards liquidation when it optimally designs and sells a debt (concave) security to raise financing. Regulations aimed at promoting ex post efficient liquidation may increase banks' financing costs and discourage their screening effort, thereby reducing welfare.

Stress Testing and Bank Lending (with Joel Shapiro)

• By assessing and dealing with bank risk (e.g. through stress tests), regulators affect the risk taken. In a model where the regulator has private information about the cost of capital requirements, the regulator may be lenient in order to encourage lending in the future. On the other hand, the regulator may be tough in order to reduce the risk of costly bank defaults. Lastly, the regulator may just relay its information accurately. These equilibria may co-exist, and due to the strategic complementarity between the regulator's stress testing strategy and the bank's lending decision, may lead to coordination failures.

Securitization, Implicit Recourse and Investment Efficiency (with Anatoli Segura)

• ​A widespread feature of securitzation is the implicit recourse provided by the originator banks. We develop a model of a bank's decision to finance investments either with traditional on-balance sheet debt or through securitization with implicit recourse. When a project failure may lead to asymmetric information about the quality of future investments, the flexibility associated with voluntarily providing recourse improves investment efficiency in the future, because it grants a good bank signaling opportunities in addition to skin-in-the-game. Yet, recourse provision requires the bank to carry spare resources on its balance sheet, which increases the funds raised from external investors above those necessary for investment. We show that securitization with implicit recourse arises when the cost of external funds is not too high. In these cases, the introduction of a ban on implicit recourse decreases the expected surplus in the economy.

Portfolio Size and the Incentives for Shareholder Activism (with Gunter Strobl)

• We analyze the investment strategy of an activist investor in a multi-firm setting in which both an intervention in a firm's operations and the threat of an intervention can improve firm value. If the value of the activist's intervention is not immediately observable to investors, we find that the activist's incentive to maximize the market value of her portfolio leads her to choose an inefficient intervention policy. In particular, we demonstrate that, compared to the first-best intervention strategy, the activist conducts too many (too few) interventions when her ability to conduct a value-enhancing intervention is low (high). A skilled activist can mitigate this inefficiency by increasing the number of firms in her portfolio. This is because a larger portfolio dilutes the threat of an intervention imposed on each firm, thereby lowering the value of the firm under the incumbent management which strengthens the activist's incentive to conduct an intervention. Our analysis thus predicts that more capable activists invest in more firms, even when their capacity to intervene in the operations of these firms is limited.

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.

Work in progress

Peer Monitoring and Interbank Markets