· “A Theory of Repurchase Agreements, Collateral Re-use and Repo Intermediation” (with Cyril Monnet and Vincent Maurin), October 2017 [download pdf]
Abstract: We show that repurchase agreements (repos) arise as the instrument of choice to borrow in a competitive model with limited commitment. The repo contract traded in equilibrium provides insurance against fluctuations in the asset price in states where collateral value is high and maximizes borrowing capacity when it is low. Haircuts increase both with counterparty risk and asset risk. In equilibrium, lenders choose to re-use collateral. This increases the circulation of the asset and generates a collateral multiplier” effect. Finally, we show that intermediation by dealers may endogenously arise in equilibrium, with chains of repos among traders.
Online Appendix [download pdf]
. “Equilibrium Theory of Banks’ Capital Structure” (with Douglas Gale), revised November 2017 [download pdf]
Abstract: We develop a general equilibrium theory of the capital structures of banks and firms. The liquidity services of bank deposits make deposits a "cheaper" source of funding than equity. Banks pass on part of this funding advantage in the form of lower interest rates to firms that borrow from them. Firms and banks choose their capital structures to balance the benefits of debt financing against the risk of costly default. An increase in the equity of a firm makes its debt less risky and that in turn reduces the risk of the banks who lend to the firm. Hence there is some substitutability between firm and bank equity. We find that firms have a comparative advantage in providing a buffer against systemic shocks, whereas banks have a comparative advantage in providing a buffer against idiosyncratic shocks.
. “Can there be a Market for Cheap-talk Information? Some Experimental Evidence” (with Antonio Cabrales, Francesco Feri and Miguel A. Meléndez-Jiménez), revised March 2018 [download pdf]
Abstract: This paper reports on experiments testing the viability of markets for cheap talk information. We find that the poor quality of the information transmitted leads to a collapse of information markets. The reasons for this are surprising given the previous experimental results on cheap-talk games. Our subjects provide low-quality information even when doing so does not increase their monetary payoff.
· “Competing Mechanisms in Markets for Lemons” (with Sarah Auster), revised March 2018 [download pdf]
Abstract: We study competitive search equilibria in a decentralized market with adverse selection, where uninformed buyers post general trading mechanisms and informed sellers select one of them. We show that this has different, significant implications with respect to the traditional approach, based on bilateral contracting between the parties: in equilibrium all buyers post the same mechanism and low quality sellers receive priority in any meeting with a buyer. Also, buyers make strictly higher profits with low than with high type sellers. When adverse selection is severe, the equilibrium features rationing and is constrained inefficient. Compared to the equilibrium with bilateral contracting, the equilibrium with general mechanisms yields a higher surplus for most, but not all, parameter specifications. Hence in some situations restricting the set of available mechanisms is welfare improving.
Online Appendix [download pdf]
· “Risk Sharing and Contagion in Networks” (with Antonio Cabrales and Fernando Vega Redondo), revised Apr. 2017, Review of Financial Studies 30(9), (Sept. 2017) 3086–3127, [download pdf]
Abstract: We investigate the properties of financial networks that tackle optimally the trade-off between risk-sharing and contagion. If the distribution of the shocks affecting firms in the system exhibits a regularity property we identify, the optimal pattern of linkages among firms is one of two polar cases: full integration or maximal segmentation. Otherwise, the optimum features intermediate degrees of segmentation or asymmetric modulation of the intensity of linkages. When firms are heterogeneous in their risk characteristics, firms form linkages optimally only to firms with the same risk profile. Finally, the individual incentives to establish linkages are sometimes misaligned with social optimality.
· “Equilibrium Corporate Finance and Intermediation” (with Alberto Bisin and Guido Ruta), revised June 2014 [download pdf]
Abstract: This paper analyzes a class of competitive economies with production, incomplete financial markets, and agency frictions. Firms take their production, financing, and contractual decisions so as to maximize their value under rational conjectures. We show that competitive equilibria exist and that shareholders always unanimously support firms' choices. In addition, equilibrium allocations have well-defined welfare properties: they are constrained efficient when information is symmetric, or when agency frictions satisfy certain specific conditions. Furthermore, equilibria may display specialization on the part of identical firms and, when equilibria are constrained inefficient, may exhibit excessive aggregate risk. Financial decisions of the corporate sector are determined at equilibrium and depend not only on the nature of financial frictions but also on the consumers' demand for risk. Financial intermediation and short sales are naturally accounted for at equilibrium.
Appendix A, revised June 2014 [download pdf]
· “Financial Contagion in Networks” (with Antonio Cabrales and Douglas Gale), revised March 2015 [download pdf], The Oxford Handbook of the Economics of Networks (Y. Bramoullé, A. Galeotti and B. Rogers, eds.), OUP
Abstract: This paper provides an introduction to the literature on financial contagion in networks. In the first part, we consider contagion via transmission of shocks, i.e. abrupt drops in the flow of revenue to one firm, which affect other firms connected to it through financial linkages. We then study informational contagion, understood as the process whereby a shock to one market is transmitted to other markets via the information revealed in the first market.
· “Flexible Contracts” (with Jean-Marc Tallon and Paolo Ghirardato), revised Dec. 2015, Games and Economic Behavior, 103 (May 2017), 145-167 [download pdf]
Abstract: This paper studies the costs and benefits of delegating decisions to superiorly informed agents, that is of adopting flexible contracts, relative to the use of rigid, non discretionary contracts. The main focus of the paper lies in the analysis of the costs of delegation, primarily agency costs, versus their benefits, primarily the flexibility of the action choice in two different environments, one with risk and one with ambiguity.
We first determine and characterize the properties of the optimal flexible contract. We then show that the higher the agent's degree of risk aversion, the higher is the agency costs of delegation and the less profitable a flexible contract relative to a rigid one. When the parties do not have sharp probability beliefs, the agent's degree of imprecision aversion introduces another agency cost, which again reduces the relative profitability of flexible contracts.
Appendix, May 2014 [download pdf].
· "Decentralizing Efficient Allocations in Economies with Adverse Selection: the General Case" (with Alberto Bisin), revised Sept. 2010 [download pdf]
Abstract: We study competitive economies with adverse selection and fully exclusive contractual relationships. We show that Walrasian equilibria always exist and are efficient for the general class of adverse selection insurance economies considered by Prescott and Townsend (1984). The result requires an appropriate expansion of the set of markets, in the spirit of Arrow (1969) and Lindahl (1919), to include markets for consumption rights so as to internalize the externality induced by the incentive constraints with adverse selection. Given the non-convexities generated by these constraints, the commodity space is enlarged to allow for lotteries. Our analysis has then also some useful implications for the study of Arrow-Lindahl equilibria in general economies in the presence of non-convexities.
· “Optimal Taxation and Debt with Uninsurable Risks to Human Capital Accumulation" (with Atsushi Kajii and Tomoyuki Nakajima), revised March 2015, American Economic Review 105(11) (Nov. 2015), 3443-3470. [download pdf]
Abstract: We consider an economy where individuals face uninsurable risks to their human capital accumulation, and analyze the optimal level of linear taxes on capital and labor income together with the optimal path of government debt. We show that in the presence of such risks it is beneficial to tax both labor and capital and to issue public debt. We also assess the quantitative importance of these findings, and show that the benefits of government debt and capital taxes both increase with the magnitude of idiosyncratic risks and the degree of relative risk aversion.
· “Dynamic Competitive Economies with Complete Markets and Collateral Constraints” (with Felix Kubler), revised Nov. 2014, The Review of Economic Studies 82(3) (July 2015), 1119-1153 [download pdf]
Abstract: In this paper we examine the competitive equilibria of a dynamic stochastic economy with complete markets and collateral constraints. We show that, provided both the set of asset payoffs and of collateral levels are sufficiently rich, the equilibrium allocations with sequential trades and collateral constraints are equivalent to those obtained in Arrow-Debreu markets subject to a series of appropriate limited pledgeability constraints. We provide necessary and sufficient conditions for equilibria to be Pareto efficient and show that when collateral is scarce equilibria are not only Pareto inefficient but also often constrained inefficient, in the sense that imposing tighter borrowing restrictions can make everybody in the economy better off. We derive sufficient conditions for the existence of Markov equilibria and, for the case of two agents, for the existence of equilibria which have finite support. These equilibria can be computed with arbitrary accuracy and the model is very tractable.
· “Capital Structure, Investment and Fire Sales” (with Douglas Gale), revised Nov. 2014, The Review of Financial Studies 28(9) (Sept. 2015), 2502-2533 [download pdf]
Abstract: We study a dynamic general equilibrium model in which firms choose their investment level and their capital structure, trading off the tax advantages of debt against the risk of costly default. The costs of bankruptcy are endogenously determined, as bankrupt firms are forced to liquidate their assets, resulting in a fire sale if the market is illiquid. When the corporate income tax rate is positive, firms have a unique optimal capital structure. In equilibrium firms default with positive probability and their assets are liquidated at fire-sale prices. The equilibrium not only features underinvestment but is also constrained inefficient. In particular there is too little debt and too little default.
Appendix B [download pdf]
· “Constrained Inefficiency and Optimal Taxation with Uninsurable Risks” (with Atsushi Kajii and Tomoyuki Nakajima), revised Aug. 2014, The Journal of Public Economic Theory 18(1) (Jan. 2016) 1-28 [download pdf]
Abstract: When individuals' labor and capital income are subject to uninsurable idiosyncratic risks, should capital and labor be taxed, and if so how? In a two period general equilibrium model with production, we derive a decomposition formula of the welfare effects of these taxes into insurance and distribution effects. This allows us to determine how the sign of the optimal taxes on capital and labor depend on the nature of the shocks, the degree of heterogeneity among consumers' income as well as on the way in which the tax revenue is used to provide lump sum transfers to consumers. When shocks affect primarily labor income and heterogeneity is small, the optimal tax on capital is positive. However in other cases a negative tax on capital is welfare improving.
· “Bankruptcy: Is It Enough to Forgive or Must We Also Forget?” (with Ronel Elul), revised Dec. 2014, American Economic Journal: Microeconomics 7(4) (Nov. 2015), 294-338 [download pdf]; A.E.A. Research highlight
Abstract: In many countries, lenders are restricted in their access to information about borrowers' past defaults. We study this provision in a model of repeated borrowing and lending with moral hazard and adverse selection. We analyze its effects on borrowers' incentives and credit access, and identify conditions under which it is welfare improving. Our model's predictions are consistent with the evidence on the impact of these credit bureau regulations on borrowers' and lenders' behavior as well as on credit provision. We also show that "forgetting" must be the outcome of a regulatory intervention.
Appendix [download pdf]
· “Markets for Information: Of Inefficient Firewalls and Efficient Monopolies” (with Antonio Cabrales), revised Aug. 2013; Games and Economic Behavior 83 (Jan. 2014), 24-44. [download pdf]
Abstract: In this paper we study market environments where information is costly to acquire and is also of use to potential competitors. Agents may then sell, or buy, reports over the information acquired and choose the trades in the market on the basis of what they learnt. Reports are unverifiable - cheap talk messages - hence the quality of the information transmitted depends on the conflicts of interest faced by the senders. We find that, when information has a prevalent horizontal differentiation component, in equilibrium information is acquired when its costs are not too high and in that case it is also sold, though reports are typically noisy. Also, the market for information is in most cases a monopoly, and there is inefficiency given by underinvestment in information acquisition. We also show that some regulatory interventions, in the form of firewalls, only make the inefficiency worse. Efficiency can be attained with a monopolist selling differentiated information, provided entry is blocked.
Appendix [download pdf]
· “Value of Information in Competitive Economies with Incomplete Markets” (with Rohit Rahi), revised Nov. 2012; International Economic Review 55(1) (Feb. 2014), 57-81. [download pdf]
Abstract: We study the value of public information in competitive economies with incomplete asset markets. We show that generically the welfare effects of a change in the information available prior to trading can be in any direction: there exist changes in information that make all agents better off, and changes for which all agents are worse off. In contrast, for any change in information, a Pareto improvement is feasible, i.e. attainable by a planner facing the same informational and asset market constraints as agents. In this sense, the response of competitive markets to changes in information is typically not socially optimal.
· “Risk Sharing and Retrading in Incomplete Markets” (with Rohit Rahi), revised Aug. 2012, Economic Theory 54 (2) (Oct. 2013), 287-304. [download pdf]
Abstract: At a competitive equilibrium of an incomplete-markets economy agents' marginal valuations for the tradable assets are equalized ex-ante. We characterize the finest partition of the state space conditional on which this equality holds for any economy. This leads naturally to a necessary and sufficient condition on information that would lead to retrade, if such information were to become publicly available after the initial round of trade.
· “Bankruptcy, Finance Constraints and the Value of the Firm” (with Douglas Gale), Aug. 2010, American Economic Journal: Microeconomics 3 (May 2011), 1-37 [download pdf]
Abstract: We study a competitive model in which market incompleteness implies that debt-financed firms may default in some states of nature and default may lead to the sale of the firms' assets at fire sale prices when a finance constraint is binding. The only frictions in the model are the finance constraint and the incompleteness of markets. The only cost of default is the sale of assets at less than their fundamental or economic value, but since there is a representative consumer, this transfer does not reduce consumers’ wealth. The anticipation of such “losses” alone may distort firms’ investment decisions. We characterize the conditions under which fire sales occur in equilibrium and their consequences on firms’ investment decisions. We also show that endogenous financial crises may arise in this environment, with asset prices collapsing as a result of pure self-fulfilling beliefs. Finally, we examine alternative interventions to restore the efficiency of equilibria.
· “Social Security and Risk Sharing” (with Felix Kubler), Sept. 2010, Journal of Economic Theory 146 (May 2011), 1078-1106. [download pdf]
Abstract: In this paper we identify conditions under which the introduction of a pay-as-you-go social security system is ex-ante Pareto-improving in a stochastic overlapping generations economy with capital accumulation and land. We argue that these conditions are consistent with realistic specifications of the parameters of the economy. In our model financial markets are complete and competitive equilibria are interim Pareto efficient. Therefore, a welfare improvement can only be obtained if agents' welfare is evaluated ex ante, and arises from an improvement in intergenerational risk sharing.
We examine the various effects of social security, on the prices of long-lived assets and the stock of capital, and hence on output, wages and risky rates of returns, can be clearly identified. In addition, we analyze the optimal size of a given social security system as well as its optimal reform.
· "Markets and Contracts" (with Alberto Bisin, John Geanakoplos, Enrico Minelli and Heraklis Polemarchakis), revised Dec. 2010, Journal of Mathematical Economics 47 (May 2011), 279-288. [download pdf]
Abstract: Economies with asymmetric information are encompassed by an extension of the model of general competitive equilibrium that does not require an explicit modeling of private information. Sellers have discretion over deliveries on contracts; this is in common with economies with default, incomplete contracts or price rigidities. Competitive equilibria exist and anonymous markets are viable. But, for a generic economy, there exist Pareto improving interventions via linear, anonymous taxes.
· “Managerial Hedging and Portfolio Monitoring" (with Alberto Bisin and Adriano Rampini), revised Dec. 2006, Journal of the European Economic Association 6 (March 2008), 158-209. [download pdf]
Abstract: Incentive compensation induces correlation between the portfolio of managers and the cash flow of the firms they manage. This correlation exposes managers to risk and hence gives them an incentive to hedge against the poor performance of their firms. We study the agency problem between shareholders and a manager when the manager can hedge his compensation using financial markets and shareholders can only imperfectly monitor the manager's portfolio in order to keep him from hedging. We find that the optimal incentive compensation and governance provisions have the following properties: (i) the manager's portfolio is monitored only when the firm performs poorly, (ii) the manager's compensation is more sensitive to firm performance when monitoring is costly or when hedging markets are more developed, and (iii) conditional on the firm's performance, the manager's compensation is lower when his portfolio is monitored, even if no hedging is revealed by monitoring. Moreover, the model suggests that the optimal level of portfolio monitoring is higher for managers of firms whose performance can be hedged more easily, such as larger firms and firms in more developed financial markets.
· “Comment on ‘Bertrand and Walras Equilibria under Moral Hazard’”, (with Belén Jerez), revised July 2007, Journal of Political Economy 115 (October 2007), 893-900. [download pdf]
Abstract: In a fundamental contribution, Prescott and Townsend (1984) have shown that the existence and efficiency properties of Walrasian equilibria extend to economies with moral hazard and exclusive contracts. Recently, Bennardo and Chiappori (2003) have argued that Walrasian equilibria may (robustly) fail to exist when the class of moral hazard economies in Prescott-Townsend is generalized to allow for aggregate, in addition to idiosyncratic, uncertainty, if preferences are nonseparable in consumption and effort. This note shows that such claim is incorrect and that the existence and efficiency properties of Walrasian equilibria remain valid in the set-up considered by Bennardo and Chiappori.
· "Local Sunspot Equilibria Reconsidered" (with Julio Davila and Atsushi Kajii), revised Jan. 2006, Economic Theory 31 (June 2007), 401-425. [download pdf]
Abstract: In this paper we propose a generalization of the usual notion of local sunspot equilibria: we say local stationary sunspot equilibria exist around a steady state of an overlapping generations economy whenever stationary sunspot equilibria of arbitrarily close economies can be found within any neighborhood of the steady state. Unlike the usual notion, this generalized notion allows us to address the following identification problem: Can an analyst distinguish empirically small fluctuations due to small shocks to the fundamentals from pure expectations-driven fluctuations? We study the conditions under which local sunspot equilibria according to the proposed notion exist in overlapping generations economies, and show in particular that they may exist not only around indeterminate steady states but also around determinate ones.
· "Efficient Competitive Equilibria with Adverse Selection" (with Alberto Bisin), revised Jan. 2006, Journal of Political Economy 114 (June 2006), 485 - 516. [download pdf]
Abstract: Do Walrasian markets function orderly in the presence of adverse selection? In particular, Is their outcome efficient when exclusive contracts are enforceable? This paper addresses these questions in the context of a Rothschild and Stiglitz insurance economy. We identify an externality associated with the presence of adverse selection as a special form of consumption externality. Consequently, we show that competitive equilibria always exist but are not typically incentive efficient. However, as markets for pollution rights can internalize environmental externalities, markets for consumption rights can be designed to internalize the consumption externality due to adverse selection.
With such markets competitive equilibria exist and incentive constrained versions of the first and second welfare theorems hold. are always incentive efficient.
Appendix, Jan. 2004. [download pdf]
· "Market Power and Information Revelation in Dynamic Trading" (with Roberto Serrano), Journal of the European Economic Association 3 (December 2005), 1279-1317 [download pdf]
Abstract: We study a strategic model of dynamic trading where agents are asymmetrically informed over common value sources of uncertainty. There is a continuum of buyers and a finite number n of sellers. All buyers are uninformed, while at least one seller is privately informed about the true state of the world. When n=1, full information revelation never occurs in equilibrium and the only information transmission happens in the first period. With n>1 the outcome depends both on the structure of the sellers' information and, even more importantly, on the intensity of competition allowed by the existing trading rules. When there is intense competition (absence of clienteles), information is fully and immediately revealed to the buyers in every equilibrium for n large enough, regardless of the number of informed sellers. On the other hand, for trading arrangements characterized by less intense forms of competition (presence of clienteles), for any n we always have equilibria where information is never fully revealed. Moreover, in that case, when only one seller is informed, for many parameter configurations there are no equilibria with full information revelation, even for large n.
· "Competitive Markets for Non-Exclusive Contracts with Adverse Selection: the Role of Entry Fees" (with Alberto Bisin), Review of Economic Dynamics 6 (April 2003), 313-338. [download pdf]
Abstract. This paper studies competitive equilibria in economies characterized by the presence of asymmetric information, where non-exclusive contracts are traded on competitive markets and agents may be privately informed over their payoff. For such economies competitive equilibria may not exist when contracts trade at linear prices. We show that (non-trivial) competitive equilibria exist, under general conditions, with a minimal requirement on the observability of agents' trades: two-part tariffs suffice, where the cost of trading each contract consists of an entry fee and a linear component in the quantity traded. The entry fee is determined at equilibrium and represents a measure of adverse selection in the economy.
· "A Note on the Regularity of Competitive Equilibria and Asset Structures" (with Atsushi Kajii), revised Oct. 2002, Journal of Mathematical Economics 39 (September 2003), 763-776. [download pdf]
Abstract: In this note we show that if markets are complete, the regularity of a given equilibrium allocation is invariant not only with respect to the choice of the equilibrium system describing the equilibrium but also with respect to the specification of the asset payoffs supporting the same equilibrium. On the other hand, if markets are incomplete regularity is typically not invariant with respect to the specification of the asset payoffs supporting a given equilibrium allocation. A (fairly strong) sufficient condition for invariance is presented.
· "Efficiency Properties of Rational Expectations Equilibria with Asymmetric Information" (with Rohit Rahi), revised March 2001.
· "A Note on the Decomposition (at a point) of Aggregate Excess Demand on the Grassmannian" (with Andreu Mas-Colell), Journal of Mathematical Economics 33 (2000), 463-473.
· "Stochastic OLG, Market Structure, and Optimality" (with Subir Chattopadhyay), Journal of Economic Theory, 89(1) (November 1999), 21-67.
· "Competitive Equilibria with Asymmetric Information" (with Alberto Bisin), Journal of Economic Theory 87(1) (July 1999), 1-48.
· "A Note on the Convergence to Competitive Equilibria in Economies with Moral Hazard" (with Alberto Bisin and Danilo Guaitoli), in P.J.J. Herings, G. Van der Laan and A.J.J. Talman, "Theory of Markets", North Holland, 1999 (pp. 229- 246).