- Capital Regulation and Shadow Finance: A Quantitative Analysis, joint with Hyunju Lee and Sunyoung Lee
This paper studies the effects of higher bank capital requirements. Using new firm-lender matched credit data from South Korea, we document that Basel III reform coincided with a 25\% decline in credit from regulated banks, and an increase of similar magnitude from non-bank (shadow) lenders. We use our data to provide robust estimates for the elasticity of bank credit with respect to capital requirements, and the spillover effect of the reform on non-bank lending. We then build a general equilibrium model with heterogeneous banks that accumulate equity and invest in corporate loans. In addition, wealthy firms may endogenously choose to become a shadow lender. The model replicates the micro estimates and suggests that Basel III can account for most of the observed decrease in regulated bank lending, and about three quarters of the increase in shadow lending. The latter is driven exclusively by general equilibrium effects of the reform.
- The Ultralong Sovereign Default Risk
Between 2010 and 2015, Mexican government issued external debt worth 0.5% of its GDP in the form of century bonds. Using a sovereign default model with endogenous maturity and variable risk-free rate, I propose a theory of the ultralong debt issuances and investigate the resulting bond spreads. Government issues such bonds in order to insure against low-frequency movements in the risk-free rate, and the benefit from such hedging is largest when interest rates are low. The model calibrated to Mexico’s default history predicts lower spreads on ultralong bonds than in the data. This suggests that Mexico is expected to remain a frequent defaulter in the next 100 years.
- Efficient Consolidation of Incentives for Education and Retirement Savings, joint with Pei Cheng Yu, R&R at AEJ: Macro
We study optimal tax policies with human capital investment and retirement savings for present-biased agents. Agents are heterogeneous in their innate ability and make risky education investments which determines their labor productivity. We demonstrate that the optimal distortions vary with education status. In particular, the optimal policy encourages human capital investment with savings incentives. Our implementation uses income-contingent student loans and existing retirement policies, augmented by a new tax instrument that subsidizes retirement savings for college graduates. The instrument mimics the latest policy proposals by allowing employers to offer 401(k) matching contributions proportional to student loans repayment.
- Borrowing into Debt Crises, joint with George Stefanidis
Quantitative models of sovereign debt predict that governments reduce borrowing during recessions to avoid debt crises. A prominent implication of this behavior is that the resulting volatility of interest rate spread is counterfactually low. We propose that governments borrow into debt crises because of frictions in the adjustment of their expenditures. We develop a model of government good production which uses public employment and intermediate consumption as inputs. The inputs have varying degrees of downward rigidity which means that it is costly to reduce them. Facing an adverse income shock, the government borrows to smooth out the reduction in public employment, which results in increasing debt and higher spread. We quantify this rigidity using the OECD government accounts data and show that it explains 72% of the missing bond spread volatility.
- Learning about Debt Crises, R&R at AEJ: Macro
The European debt crisis presents a challenge to our understanding of the relationship between government bond yields and economic fundamentals. I argue that information frictions are an important missing element, and support that claim with evidence on the evolution of GDP forecast errors in 2008-2014. I build a quantitative model of sovereign default where output features rare disasters and agents learn about their realizations. Debt crises coincide with economic depressions and develop gradually while markets update their expectations about future income. Calibrated to Portuguese economy, the model replicates the comovement of bond spreads and output before and after 2008.
- Commitment versus Flexibility and Sticky Prices: Evidence from Life Insurance, joint with Pei Cheng Yu, R&R at RED
Life insurance premiums display significant rigidity in the data, on average adjusting once every 3 years by more than 10%. This contrasts with the underlying marginal cost which exhibits considerable volatility due to the movements in interest and mortality rates. We build a dynamic model where policyholders are held-up by long-term insurance contracts which presents a time inconsistency problem for the firms. The optimal contract takes the form of a simple cutoff rule: premiums are rigid for cost realizations smaller than the threshold, while adjustments must be large and are only possible when cost realizations exceed it. We use a calibrated version of the model to show that it matches the data and captures several aspects of premium rigidity in the cross-section and over time.