Bank Opacity and Endogenous Uncertainty

Presentada comunicación en el Barcelona GSE Winter Workshop on Microeconomics, celebrado el 18 de diciembre de 2013 en Barcelona (España). Presentada comunicación en la European Economic Association & Econometric Society, 2014 Parallel Meetings, celebrados del 25 al 29 de agosto de 2014 en Toulose (Francia)Why are banks opaque? Is there a need for policy? What is the optimal level of bank transparency? In this model, banks are special because the product they are selling is superior information about investment opportunities. Intransparent balance sheets turn this public good into a marketable private commodity. Voluntary public disclosure of this information translates into a competitive disadvantage. Bank competition results in a "race to the bottom" which leads to complete bank opacity and a high degree of aggregate uncertainty for households. Households do value public information as it reduces aggregate uncertainty, but the market does not punish intransparent banks. Policy measures can improve upon this market outcome by imposing minimum disclosure requirements on banks. Complete disclosure is socially undesirable as this eliminates all private incentives for banks to acquire costly information. The social planner chooses optimal bank transparency by trading off the benefits of reducing aggregate uncertainty for households against banks' incentives for costly information acquisitionPeer Reviewe

Bank opacity and financial crises

This paper studies a model of endogenous bank opacity. In the model, bank opacity is costly for society because it reduces market discipline and encourages banks to take on too much risk. This is true even in the absence of agency problems between banks and the ultimate bearers of the risk. Banks choose to be inefficiently opaque if the composition of a bank's balance sheet is proprietary information. Strategic behavior reduces transparency and increases the risk of a banking crisis. The model can explain why empirically a higher degree of bank competition leads to increased transparency. Optimal public disclosure requirements may make banks more vulnerable to a run for a given investment policy, but they reduce the risk of a run through an improvement in market discipline. The option of public stress tests is beneficial if the policy maker/nhas access to public information only. This option can be harmful if the policy maker has access to banks' private information

Bank opacity and financial crises

This paper studies a model of endogenous bank opacity. Why do banks choose to hide their risk exposure from the public? And should policy makers force banks to be more transparent? In the model, bank opacity is costly because it encourages banks to take on too much risk. But opacity also reduces the incidence of bank runs (for a given level of risk taking). Banks choose to be inefficiently opaque if the composition of their asset holdings is proprietary information. In this case, policy makers can improve upon the market outcome by imposing public disclosure requirements (such as Pillar Three of Basel II). However, full transparency maximizes neither efficiency nor stability. The model can explain why empirically a higher degree of bank competition leads to increased transparency.I am grateful for financial support from the European Union through ADEMU (Horizon 2020 Grant 649396) and ERC Advanced Grant (APMPAL) GA 324048, from the Spanish Ministry of Economy and Competitiveness through the Severo Ochoa Programme for Centres of Excellence in R&D (SEV-2015-0563) and through Grant ECO2013-48884-C3-1P, and from the Generalitat de Catalunya (Grant 2014 SGR 1432).Peer Reviewe

Credit market failure and macroeconomics

Examining Board: Professor Árpád Ábrahám, European University Institute (Supervisor) Professor Hugo A. Hopenhayn, UCLA Professor Ramon Marimon, European University Institute Professor Vincenzo Quadrini, University of Southern California.Defence date: 14 November 2013First made available online on 3 February 2014.This thesis aims to contribute to our understanding of the relationship between market failure on capital markets and macroeconomic outcomes in various forms. The notion of credit markets as a frictionsless veil over real economic activity has proven to be unfruitful with respect to many questions of economic interest. To name only a few examples, in the absence of financial frictions there is no difference between internal and externalfinancing, no trade-off between equity and debt, and there is no reason for banks to exist. In order to correctly identify and address the policy needs which might arise from credit market failure, we need to learn more about the fundamental conditions which give rise to the financial contracts and institutions observed in reality. The first chapter of this thesis focuses on the phenomenon of the publicly traded firm with its separation of ownership and control. I show how a time-varying misalignment of incentives of firm managers and investors can have important consequences for aggregate business fluctuations. In particular, a rise in idiosyncratic firm-level uncertainty may result in an economy-wide increase in the default rate on corporate bonds together with a drop in measured firm productivity and output. Bank transparency is the topic of the second chapter. In this model, banks are special because the product they are selling is superior information about investment opportunities. Intransparent balance sheets turn this public good into a marketable private commodity. In the absence of policy intervention, bank competition results in complete bank opacity and a high degree of aggregate uncertainty for households. Mandatory disclosure rules can improve upon the market outcome. The third chapter is joint work with David Strauss. It focuses on the consequences of credit market failure for development and growth. We show that capital market imperfections may give rise to a poverty trap associated with permanent productivity differences across countries. Key to this phenomenon is a sorting reversal in the matching between human capital and heterogeneous production sectors

Bank opacity and financial crises

This paper studies a model of endogenous bank opacity. In the model, bank opacity is costly for society because it reduces market discipline and encourages banks to take on too much risk. This is true even in the absence of agency problems between banks and the ultimate bearers of the risk. Banks choose to be inefficiently opaque if the composition of a bank’s balance sheet is proprietary information. Strategic behavior reduces transparency and increases the risk of a banking crisis. The model can explain why empirically a higher degree of bank competition leads to increased transparency. Optimal public disclosure requirements may make banks more vulnerable to a run for a given investment policy, but they reduce the risk of a run through an improvement in market discipline. The option of public stress tests is beneficial if the policy maker/nhas access to public information only. This option can be harmful if the policy maker has access to banks’ private information

Capital structure, uncertainty, and macroeconomic fluctuations

Presentada comunicación en el Barcelona GSE Economics "Trobada" XI, celebrada el 18 de octubre de 2013 en Barcelona (España)Peer Reviewe

Bank opacity and financial crises

This paper studies a model of endogenous bank opacity. In the model, bank opacity is costly for society because it reduces market discipline and encourages banks to take on too much risk. This is true even in the absence of agency problems between banks and the ultimate bearers of the risk. Banks choose to be inefficiently opaque if the composition of a bank’s balance sheet is proprietary information. Strategic behavior reduces transparency and increases the risk of a banking crisis. The model can explain why empirically a higher degree of bank competition leads to increased transparency. Optimal public disclosure requirements may make banks more vulnerable to a run for a given investment policy, but they reduce the risk of a run through an improvement in market discipline. The option of public stress tests is beneficial if the policy maker/nhas access to public information only. This option can be harmful if the policy maker has access to banks’ private information

Debt dilution and debt overhang

We introduce long-term debt (and a maturity choice) into a standard model of firm financing and investment. This allows us to study two distortions of investment: (1.) Debt dilution distorts firms’ choice of debt which has an indirect effect on investment; (2.) Debt overhang directly distorts investment. In a dynamic model of investment, leverage, and debt maturity, we show that the two frictions interact to reduce investment, increase leverage, and increase the default rate. We provide empirical evidence from U.S. firms that is consistent with the model predictions. Using our model, we isolate and quantify the effect of debt dilution and debt overhang. Debt dilution is more important for firm value than debt overhang. Debt overhang can actually increase firm value by reducing debt dilution. The negative effect of debt dilution on investment is about half as strong as that of debt overhang. Eliminating the two distortions leads to an increase in investment equivalent to a reduction in the corporate income tax of 3.5 percentage points.The ADEMU Working Paper Series is being supported by the European Commission Horizon 2020 European Union funding for Research & Innovation, grant agreement No 649396