Essays on Macroeconomics,Financial Intermediation,and Leverage.
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The recent financial crisis demonstrated the macroeconomic importance of financial intermediaries. My dissertation uses equilibrium models to study the interaction between financial intermediation and aggregate economic conditions. Chapter 1: Financial Intermediation,Leverage,and Macroeconomic Instability. Many economists believe excessive bank leverage played a critical role during the crisis but do not agree what appropriate leverage regulation should be. I ask how banks portfolio choices affect macroeconomic stability. In particular,how does regulating leverage change the evolution of the financial sector and the frequency and duration of good and bad aggregate outcomes? To answer these questions,I present a continuous-time general equilibrium model in which banks are useful for allocating resources and providing liquidity. Households and banks can invest in two types of risky projects,producing two different goods,and banks have an advantage in one type of project. Banks use households preferences to discount dividends paid to shareholders,but banks are limited in their ability to issue equity. This implies: banks portfolio choices depend on current equity levels； agents primarily trade non-contingent contracts debt)； banks increase leverage to invest more. I solve for the global dynamics of the economy as the level of bank equity fluctuates. Compared to when banks can freely issue equity,banks raise the volatility of asset prices when they collectively change their portfolios,and higher volatility increases how frequently banks have low levels of equity. Financial sector volatility decreases the mean level of aggregate outcomes because equity levels fall on average faster than they rise. After a sequence of good fundamental shocks,bank equity increases and banks pay dividends,but after bad shocks banks are still limited in their ability to issue equity. With larger shocks,banks are in trouble more often. When in trouble,banks cut back on risk-taking,which depresses economic activity. Because of limited equity issuance,the marginal value of bank equity---both the direct value to shareholders and the indirect value to households---is greater than the marginal utility of consumption,and so welfare depends critically on how bank equity evolves. Bank leverage determines the size of the distortion in each state,as well as the probability of,and transition between,states-all of which agents take as given. Regulating leverage alters the severity of aggregate outcomes,but it also affects the frequency and duration of aggregate outcomes by modifying the evolution of the financial sector. Chapter 2: Correlation,Costly Enforcement,and Financial Intermediation. Why do financial intermediaries hold portfolios with correlated risk? Can concentrated risk-taking facilitate intermediation? I investigate these questions using a costly enforcement model in which lenders need ex post incentives to enforce payments from defaulted loans. When projects have correlated outcomes,learning the state of one project via enforcement) provides information about the states of other projects. Lenders can commit to enforcement by holding a large,correlated portfolio,and as a result borrowers default less frequently. Intermediaries financed with risk-free liabilities emerge naturally. A large intermediary can commit to enforcement when individual lenders cannot and so can promise a sure payment that is larger than the expected payment lenders could get from lending directly to borrowers. Furthermore,investors never need to enforce the intermediarys payments because the payments are not state-contingent. Chapter 3: Collateral Constraints and the Ambiguous Effects of Increased Uncertainty. I use general equilibrium models with collateral constraints to show that uncertainty and other belief changes can have ambiguous effects on leverage,loan margins,loan amounts,and asset prices. This is because when an asset is used for collateral,the assets payoff is split between the borrower and lender: the borrower receives the asset when there is no default,and the lender receives the asset when the borrower defaults. Thus,each agent prices the asset but in different states,and changing the distribution of the assets payoffs can change which agents price the asset for which states. For example,even when lenders are risk-averse and borrowers can default,increasing uncertainty about future payoffs can lead to riskier loans with larger balances and lower spreads.