Working Papers

Global vs. Local Banking: A Double Adverse Selection Problem


Winner of the Young Economists’ Competition, ECB Forum on Central Banking

This paper provides a new theory of firm financing in financial systems with both global and local banks, and tests it using cross-country loan-level data. I point out that the traditional theory in corporate finance and banking of firm-bank sorting based on hard versus soft information does not explain the sorting patterns between firms and global versus local banks. Instead, global banks have a comparative advantage in extracting global information, and local banks have a comparative advantage in extracting local information. I formalize this view in a model in which firms have returns dependent on global and local risk factors, and each bank type can observe only one component of the firms’ returns. This double information asymmetry creates a segmented credit market with a double adverse selection problem: in equilibrium, each bank lends to the worst type of firms in terms of the unobserved risk factors. Moreover, when one of the bank types faces a funding shock (e.g., a monetary policy shock), the adverse selection affects firm financing at both the extensive and intensive margins, generating spillover and amplification effects through adverse interest rates. I test the theory using detailed firm-bank micro data and empirical strategies that tightly map to the model set-up. I find firm-bank sorting patterns, and effects of US and Euro area monetary policy shocks on credit allocation across firms, that support the model predictions. This evidence reveals a novel adverse selection channel of international monetary policy transmission.

Scarred Consumption

with Ulrike Malmendier


We show that personal lifetime experiences can “scar” consumers: Having lived through times of high unemployment, consumers have persistently pessimistic beliefs about their future financial situation, even though their actual future income is uncorrelated with those past experiences, after controlling for income, demographics, and time effects, and future wealth build-up is positively related. Nevertheless worse lifetime experiences predict significantly reduced consumption spending, after including the same set of controls. The results hold both between and within households, and are robust to a battery of variations in liquid- and illiquid wealth controls, in income controls, and further robustness checks. We use the stochastic life-cycle model of Low, Meghir, and Pistaferri (2010) to show that financial constraints, income scarring, and unemployment scarring fail to generate the estimated negative relationship between experiences and consumption. It is instead consistent with experience-based learning, i. e., the notion that consumers per- sistently overweight past experiences in their belief formation process. We replicate the PSID results in the Nielsen Homescan Panel, and the Consumer Expenditure Survey (CEX). The Nielsen data also reveals that households who have lived through times of high unemployment are particularly likely to use coupons and to purchase sale items or lower-end products. Moreover, as predicted by experience-based learning models, the effects of a macro shock are stronger for younger than for older cohorts. Our results sug- gest a novel micro-foundation of fluctuations in aggregate demand, and explain long-run effects of macroeconomic shocks.

Capital Flows, House Prices, and the Real Economy: A “China Shock” in the US Real Estate Market

with Zhimin Li and Calvin Zhang


We analyze the house price and real economic effects of home purchases by foreign Chinese on US local economies. Using housing transaction data in California from 2001 to 2013, we document a “China shock” in the US real estate market driven by government policies restricting home purchases in China: the share of foreign Chinese housing purchases by value and count in California increased twentyfold after 2007. In particular, these purchases exhibit a form of “home bias” as they are concentrated in zip codes historically populated by ethnic Chinese, making up more than 12% of total transactions in these neighborhoods in 2013. We exploit the spatial variation of historical ethnic Chinese settlement across zip codes to identify differential exposure to real estate capital inflows from China. We find that foreign Chinese housing purchases have a significant and positive impact on local housing and labor markets. A one standard deviation increase in exposure to these purchases explains 19% and 16% of the cross-zip-code variation in local housing prices and local employment, respectively, with the latter effect concentrated in non-tradable sectors. We present evidence that the labor market response is transmitted through a housing net worth channel and highlight the stabilizing role of foreign capital inflows during economic downturns.

Consumption Quality: A New Perspective on the Welfare Implications of Business Cycle Fluctuations

with Casper Nordal Jørgensen


This paper introduces a new approach for estimating the welfare costs of business cycle fluctuations. We quantify and evaluate a new channel that consumers use to smooth macroeconomic shocks—the quality channel of consumption reallocation. Using detailed micro-level panel data on household expenditures, we show that there exists significant heterogeneity in the degree of reallocation across the quality vs. quantity margins of consumption reallocation across income groups: high-income households tend to adjust their consumption at the quality channel when facing negative shocks, while the low-income households are more likely to adjust at the quantity margin. Our results suggest the poor may be rationed in their margins of consumption reallocations when hit by a negative shock and thereby bear a disproportionately greater share of the cost of business cycle fluctuations. We develop a model in which households have non-homothetic preferences and value both the quality and quantity of purchased products. Using the model, we estimate the structural parameters that are consistent with the patterns of consumption behavior observed in the data and analyze the welfare implications of business cycles fluctuations.

Valuing Bank Complexity

with Linda Goldberg

(Draft available upon request)

Banks have progressively evolved from mainly standalone entities toward financial conglomerates that are complex in organizational structure, business scope, and geographical reach. We investigate the role of complexity in market valuation of US banking organizations, using detailed information on the structure of all publicly listed bank holding companies over the period 1990-2017. We find that more organizationally complex banking organizations have significantly lower risk-adjusted equity returns, conditional on standard risk factors and bank size. The results point to a complexity factor in bank returns. This factor is sensitive to bank regulatory changes, suggesting that the market incorporates potential government guarantees for too-complex-to-fail banks in its pricing.