Refinancing Frictions, Mortgage Pricing and Redistribution
with David Berger, Konstantin Milbradt and Joe Vavra; November 2022
Abstract: There are large cross-sectional differences in how often US borrowers refinance mortgages. In this paper, we develop an equilibrium mortgage pricing model that allows us to explore the consequences of this heterogeneity. We show that equilibrium forces imply important cross subsidies from borrowers who rarely refinance to those who refinance often. Mortgage reforms can potentially reduce these regressive cross-subsidies, but the equilibrium effects of these reforms can also have important distributional consequences. For example, many policies which lead to more frequent refinancing lead to higher equilibrium mortgage rates and reduce residential mortgage credit access for a large number of borrowers.
Sovereign Debt Ratchets and Welfare Destruction,
with Peter DeMarzo and Zhiguo He; July 2022; Journal of Political Economy, accepted
Abstract: We model an impatient, risk-neutral government that cannot commit to a particular fiscal path, financed by competitive lenders. In equilibrium, debt adjusts slowly towards a target debt-to-income level, exacerbating booms and busts. Strikingly, gains from trade dissipate when trading is continuous, leaving the government no better off than in financial autarky, due to a “sovereign debt ratchet effect.” Moreover, citizens who are more patient than their government are strictly harmed. We characterize equilibrium debt dynamics, ergodics, and comparative statics when income follows a geometric Brownian motion, and analyze commitment devices that allow the sovereign to recapture some gains from trade.
Can the Cure Kill the Patient? Corporate Credit Interventions and Debt Overhang,
with Nicolas Crouzet; May 2021; Revise and resubmit at the Journal of Finance
Abstract: Interventions in corporate credit markets were a major innovation in the policy response to the 2020 recession. This paper develops and estimates a model to quantify their impact on borrowing and investment. Even during downturns, credit interventions can be a bad policy idea, because they exacerbate debt overhang and depress investment in the long run. However, if the downturn is accompanied by financial market disruptions, they initially help forestall inefficient liquidations. These short term benefits quantitatively dominate the long run overhang costs. Additionally, constraining shareholder distributions, and targeting high-leverage firms substantially increases the “bang for the buck” of credit interventions.
Comparative Valuation Dynamics in Models with Financing Restrictions,
with Lars P. Hansen and Paymon Khorrami
Rigid Wages, Seniority Rules, and Unemployment Duration,
with Fernando Alvarez and Rob Shimer
Abstract: This paper examines the impact of unions on unemployment and wages in a dynamic equilibrium search model. We model a union as imposing a minimum wage and rationing jobs to ensure that the union’s most senior members are employed. This generates rest unemployment, where following a downturn in their labor market, unionized workers are willing to wait for jobs to reappear rather than search for a new labor market. Introducing unions into a dynamic equilibrium model has two implications, which others have argued are features of the data: the hazard of exiting unemployment at long durations is very low when the union-imposed minimum wage is high; and a high union-imposed minimum wage generates a compressed wage distribution and a high turnover rate of jobs.
A Macro-Finance Approach to Sovereign Debt Spreads and Returns,
Abstract: Foreign currency sovereign bond spreads tend to be higher than historical sovereign credit losses, and cross-country spread correlations are larger than their macro-economic counterparts. Foreign currency sovereign debt exhibits positive and time-varying risk premia, and standard linear asset pricing models using US-based factors cannot be rejected. The term structure of sovereign credit spreads is upward sloping, and inverts when either (a) the country’s fundamentals are bad or (b) measures of US equity or credit market stress are high. I develop a quantitative and tractable continuous-time model of endogenous sovereign default in order to account for these stylized facts. My framework leads to semi-closed form expressions for certain key macro-economic and asset pricing moments of interest, helping disentangle which of the model features inﬂuences credit spreads, expected returns and cross-country correlations. Standard pricing kernels used to explain properties of US equity returns can be nested into my quantitative framework in order to test the hypothesis that US-based bond investors are marginal in sovereign debt markets. I show how to leverage my model to study the early 1980’s Latin American debt crisis, during which high short term US interest rates and ﬂoating rate dollar-denominated debt led to a wave of sovereign defaults.
Empirical Appendix to: A Macro-Finance Approach to Sovereign Debt Spreads and Returns
Abstract: This Internet appendix contains a detailed empirical discussion on sovereign credit spreads and returns. While past empirical work on this topic has leveraged sovereign bond price data, I instead use credit default swap data to provide additional support for several known facts. First, I show that investors in hard currency sovereign debt markets do not behave in a risk-neutral fashion. I then provide suggestive evidence that investors’ level of risk-aversion is time-varying, and is positively correlated with measures of US credit or equity market risk. Finally, I provide evidence on the term structure of sovereign credit spreads and returns, which inform the construction, estimation and validation of the model developed in the main paper.
Mortgage Prepayment and Path-Dependent Effects of Monetary Policy,
with David Berger, Konstantin Milbradt and Joseph Vavra; September 2021; American Economic Review