Research

Working Papers

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.

Sovereign Debt Ratchets and Welfare Destruction,

with Peter DeMarzo and Zhiguo He; March 2021; Revise and resubmit at the Journal of Political Economy

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.

Comparative Valuation Dynamics in Models with Financing Restrictions,

with Lars P. Hansen and Paymon Khorrami

Abstract: 

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.

Refereed Publications

Mortgage Prepayment and Path-Dependent Effects of Monetary Policy,

with David Berger, Konstantin Milbradt and Joseph Vavra; September 2021; American Economic Review

Abstract: How much ability does the Fed have to stimulate the economy by cutting interest rates? We argue that the presence of substantial debt in fixed-rate, prepayable mortgages means that the ability to stimulate the economy by cutting interest rates depends not just on their current level but also on their previous path. Using a household model of mortgage prepayment matched to detailed loan-level evidence on the relationship between prepayment and rate incentives, we argue that recent interest rate paths will generate substantial headwinds for future monetary stimuli.