Institut d'AnÓlisi Econ˛mica
We introduce risky long-term debt (and a maturity choice) to a dynamic model
of firm financing and production. This allows us to study two distortions which are
absent from standard models of short-term debt: (1.) Debt dilution distorts firmsĺ
choice of debt which has an indirect effect on investment; (2.) Debt overhang
directly distorts investment. In a dynamic model of production, leverage, and
debt maturity, we show that the two distortions 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. Debt dilution and
debt overhang can overturn standard results: A financial reform which increases
investment, employment, output, and welfare in a standard model of short-term
debt can have the opposite effect in a model with short-term debt and long-term
The Long-term Debt Accelerator
We introduce risky long-term debt to a dynamic model
of firm financing and production. This allows us to identify a novel amplification mechanism: the Long-term
Debt Accelerator. A negative shock triggers an adverse feedback loop between
low investment and high credit spreads. Relative to a frictionless RBC setup, the
Long-term Debt Accelerator amplifies shocks by about 150%. This amplification
mechanism is absent from a standard short-term debt model. If firms accumulate more debt during
a boom (e.g. because of low fundamental volatility), the subsequent recession
is more severe. The Long-term Debt Accelerator is in line with the empirically
observed counter-cyclical behavior of credit spreads and leverage.
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.
A Blessing in Disguise? Market Power and Growth with Financial Frictions
Firm market power raises growth in the presence of financial frictions. The
reason is that self financing becomes more effective if firm earnings are higher.
We test this mechanism using Korean manufacturing data 1963-2003. We find
that more concentrated sectors grow faster. This positive empirical relationship
between concentration and growth gets weaker as credit becomes more abundant.
Using a simple growth model, we study counterfactuals. The observed rise of
concentration in Korea until the mid-1970s has increased manufacturing value
added 1963-2003 on average by at least 0.6% per year. The effect of firm market
power on worker welfare is ambiguous.
I am teaching the second part of the class on Foundations of Equilibrium Analysis in the Macroeconomic Policy and Financial Markets Program of the Barcelona GSE.