A new paper on “Unsecured and Secured funding is available on SSRN
We empirically investigate why wholesale funding is fragile by providing the first study how individual banks borrow and lend in the euro unsecured and secured interbank market. Consistent with theories in which lenders enforce market discipline by monitoring counterparty credit risk and theories highlighting that secured loans are less informational sensitive, we find that banks with low credit worthiness replace unsecured borrowing with secured loans. Similarly, riskier lenders provide more secured loans to replace unsecured lending, which is not consistent with speculative or precautionary liquidity hoarding theories. Instead, lenders are precautionary in the sense that they prefer to lend against safe collateral.
I have a new paper on “Fragility of Money Markets” (with Angelo Ranaldo and Matthias Rupprecht).
We provide the first comprehensive theoretical model for money markets encompassing unsecured and secured funding, asset markets, and central bank policy. Capital-constrained, leveraged banks invest in assets and raise short-term funds by borrowing in the unsecured and secured money markets. Our model derives how funding liquidity across money markets is related, explains how a shock to asset values can lead to mutually reinforcing liquidity spirals in both money markets, and shows how borrowers’ flight-to-safety and risk-seeking behavior impacts their liability structure. We derive the socially optimal leverage and funding structure and show which combination of conventional and unconventional monetary policies and regulatory measures can reduce money market fragility.
The paper is available on SSRN.
The paper “The Euro Interbank Repo Market” has been accepted and is now forthcoming in The Review Of Financial Studies. The corrected proof is available on the publisher’s website. You can still find the last working paper version of the paper on SSRN.
The search for a market design that ensures stable bank funding is at the top of regulators’ policy agenda. This paper empirically shows that the central counterparty (CCP)-based euro interbank repo market features this stability. Using a unique and comprehensive data set, we show that the market is resilient during crisis episodes and may even act as a shock absorber, in the sense that repo lending increases with risk, while spreads, maturities, and haircuts remain stable. Our comparison across different repo markets shows that anonymous CCP-based trading, safe collateral, and the absence of an unwind mechanism are the key characteristics to ensure market resilience.
Today, I uploaded a completely revised version of my working paper with Fabio Trojani and Christian Wiehenkamp on SSRN. The new title is “Ambigutiy and Reality”.
Model builders face ambiguity about the true data generating process. Consequently, they need to deal with ambiguity attitudes (inside uncertainty) and ambiguous financial reality (outside uncertainty) when developing and estimating financial models. We introduce a novel approach for systematically dealing with outside uncertainty in addition to inside uncertainty in a tractable way. By bounding the effects of ambiguous data features, we avoid the adverse consequences of outside uncertainty, such as strongly biased equity premiums and investment policies. In a real data application, we show that asset managers can be more reliably evaluated using our bounded-influence approach.
You can download the full paper on SSRN.