Nov 2017 Revise and Resubmit at Journal of Finance
Abstract: Banks are important because firms hold their debt ("inside money") as liquidity buffer. Banking crises are costly because the contraction of inside money supply compromises firms' liquidity management and hurts investment. By highlighting the interaction between banks and firms in the money market, this paper offers a theory of procyclical inside money creation and the resulting instability. It sheds light on the cyclicality of bank leverage, and how it affects the frequency and duration of banking crises. Introducing outside money (government debt) to alleviate liquidity shortage can be counterproductive, because its competition with inside
money destabilizes the banking sector.     
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Presentations: Becker Friedman Institute (University of Chicago), Chicago Booth, CEPR Credit Cycle Conference, Columbia Business School, Columbia Economics, Econometric Society (Europe), Finance Theory Group, Georgetown McDonough, Gradudate Institute (Geneva), Imperial College, Johns Hopkins, London School of Economics, Lund University Arne Ryde Conference, MFA, Nanyang Technological University, New York Fed, Northwestern Kellogg, NYU Stern PhD Seminar, OSU Fisher, Oxford Financial Intermediation Theory Conference, University of Melbourne, USC Marshall, Wharton, MFA

Sep 21, 2018  

Abstract: Firms hold money market instruments issued by banks to finance non-pledgeable intangible investments. This liquidity demand pushes down the interest rate in money markets, feeding banks cheap leverage, so banks bid up asset prices in booms as their balance sheets expand. Higher asset prices induce firms to invest more in intangibles and hold more liquidity, which in turn leads to an even lower interest rate, faster growing banks, and higher asset prices. This paper models corporate savings gluts that arise endogenously from the interaction between firms and banks in asset and money markets. It offers a coherent account of several seemingly disconnected phenomena in the run-up to the Great Recession, and reveals how endogenous risk accumulates in asset prices during booms and materializes into stagnant crises. Government debt as an alternative source of liquidity stimulates intangible investments and economic growth, but it cannot reduce asset price volatility or the frequency of banking crises.

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Presentations: WFA (Western Finance Association), European Winter Finance Summit (Best Paper Prize), EFA (European Finance Association), CEPR ESSFM Gerzensee, SED (Society for Economic Dynamics), Econometric Society (North America), 7th HKUST Macro Workshop, CMU/OSU/Pittsburgh/Penn State conference; earlier version at:  Columbia University, Federal Reserve Bank of New York, Finance Theory Group (parallel session), LBS Trans-Atlantic Doctoral Conference

with Lin William Cong, Neng Wang, Sep 16, 2018

We provide a dynamic asset-pricing model of cryptocurrencies/tokens on platforms and highlight their roles on endogenous user adoption. Tokens facilitate transactions among decentralized users and allows them to capitalize future growth of promising platforms. Tokens thus can accelerate adoption, reduce user-base volatility, and improve welfare. Token price increases non-linearly in platform productivity, users' heterogeneous transaction needs, and endogenous network size. The growth of user base starts slow, becomes explosive and volatile, and eventually tapers off. Our model can be extended to discuss platform token supply, cryptocurrency competition, and pricing assets under network externality.

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Presentations: 2018 AAM-CAMRI-CFA Institute Prize in Asset Management, 2019 RCFS/RAPS Conf. at Baha Mar, CEPR ESSFM Gerzensee Workshop, Chicago Booth, City University of Hong Kong International Finance Conference, Emerging Trends in Entrepreneurial Finance Conference (Best Paper Award), Finance UC 14th International Conference, Georgetown University, JOIM Conference on FinTech, London Finance Theory Group Summer Conference, Norwegian School of Economics, Rome Junior Finance Conference, SEC DERA, Shanghai Forum, Stanford SITE, U Washington Foster School of Business, and UT Dallas Finance Conference


with Chen Wang, Nov 19, 2018 

Abstract: Delegation bears an intrinsic form of uncertainty. Investors hire managers for their superior models of asset markets, but delegation outcome is uncertain precisely because managers' model is unknown to investors. We model investors' delegation decision as a trade-off between asset return uncertainty and delegation uncertainty. Our theory explains several puzzles on fund performances. It also delivers asset pricing implications supported by our empirical analysis: (1) because investors partially delegate and hedge against delegation uncertainty, CAPM alpha arises; (2) the cross-section dispersion of alpha increases in uncertainty; (3) managers bet on alpha, engaging in factor timing, but factors' alpha is immune to the rise of their arbitrage capital - when investors delegate more, delegation hedging becomes stronger. Finally, we offer a novel approach to extract model uncertainty from asset returns, delegation, and survey expectations.

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Presentations:  CEPR ESSFM Gerzensee, CUHK, European Winter Finance Summit (EWFS), Geneva Workshop on Financial Stability, MFA 2019, University of Zurich


 with Edward Denbee, Christian Julliard, Kathy Yuan, Sep 11, 2018

Abstract:   We estimate the liquidity multiplier and individual banks’ contribution to systemic risk in an interbank network using a structural model. Banks borrow liquidity from neighbors and update their valuation based on neighbors' actions. When the former (latter) motive dominates, the equilibrium exhibits strategic substitution (complementarity) of liquidity holdings, and a reduced (increased) liquidity multiplier dampening (amplifying) shocks. Empirically, we find substantial and procyclical network-generated risks driven mostly by changes of equilibrium type rather than network topology. We identify the banks that generate most systemic risk and solve the planner's problem, providing guidance to macro-prudential policies.

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Youtube video: network evolution in our sample

Presentations:  NBER SI 2018, Macro Finance Society, Bank of England, Cass Business School, Duisenberg School of Finance, Koc University, London School of Economics, Stockholm School of Economics, OSU Fisher WFA , 5th Joint Bank of Canada / Payments Canada Workshop on Payment Systems, 2018 Fed/OFR Financial Stability: Markets and Spillovers


 with Chen Wang, Sep 30, 2018

Abstract: The ratio of long- to short-term dividend prices, "price ratio" (pr), predicts one-year stock market return with an out-of-sample R2 of 19%. It subsumes the predictive power of price-to-dividend ratio (pd). The residual from regressing pd on pr predicts one-year dividend with an out-of-sample R2 of 30%. Our results hold outside the U.S. In an exponential-affine model, we show the key to understand these findings is the (lack of) persistence of expected dividend growth. We also characterize the risk of time-varying expected return: (1) the expected return is countercyclical; (2) the response of expected return (rather than expected dividend growth) accounts for the impact of monetary policy on stock price; (3) shocks to pr are priced in the cross-section, which serves as an ICAPM test of pr as an adequate proxy for the expected return.

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Presentations: 16th Paris December Finance Meeting,  2019 RCFS/RAPS Conf. at Baha Mar, Econometric Society (North America), Fall Finance Conference at UT Dallas, HKUST Finance Symposium, Northern Finance Association (NFA), Örebro Workshop on Predicting Asset Returns


with Yi Huang, Hongzhe Shan, Dec 2018 (under data provider review)

Abstract: As transaction and data hubs, e-commerce platforms are uniquely positioned to extend credit to users and have become leading players in FinTech. This paper provides the first evidence on how platform credit shapes the e-commerce market structure. Using data from Alibaba, we estimate the causal effects of platform credit on the allocation of customer attention, and as a result, the sales distribution of e-commerce merchants. We find that platform credit amplifies the selection of merchants by customers, and thereby, can contribute to platform prosperity especially through the cross-side externality.

Presentations: 2018 Finance, Organizations, and Markets (FOM) Conference, AFA 2019, Bank of Canada, FDIC Annual Bank Research Conference, Fed Board, NTU, NUS, MIT Econ, OSU Fisher