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.

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.

Feb 2018  New Version!  

Abstract: Does the rise of intangible capital create financial instability? Firms hoard liquidity in the form of bank debt (e.g., deposits) for non-pledgeable intangible investments. This liquidity demand pushes down interest rate, giving banks a funding cost advantage, so banks bid up asset prices in booms as they grow. Higher asset prices induce firms to invest more in intangibles and hoard more liquidity, leading to an even lower interest rate and enabling banks to bid up asset prices even further. This paper models corporate savings glut that arises endogenously from the interaction between firms and banks in asset and money markets. The feedback mechanism explains several concurrent phenomena in the run-up to the Great Recession, and how endogenous risk accumulates in booms and materializes into severe and stagnant crises.

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

with Edward Denbee, Christian Julliard, Kathy Yuan, Jan 2018 New Version!

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.

Presentations: Bank of England, Cass Business School, Duisenberg School of Finance, Koc University, London School of Economics , Macro Finance Society annual meeting, OSU Fisher, Stockholm School of Economics, WFA

with Chen Wang, Jan 2018  New Version!

Abstract: The prices of dividends at alternative horizons contain critical information on the behavior of aggregate stock market. The ratio between prices of long- and short-term dividends, "price ratio" (pr), predicts annual market return with an out-of-sample R2 of 19%.  pr subsumes the predictive power of traditional price-dividend ratio (pd). After orthogonalized to pr, the residuals of pd strongly predicts dividend growth. The economic intuition behind can be easily understood in an exponential-affine framework, and our findings have important implications on the structural parameters. We also find return predictability is stronger after market downturns, and holds outside the U.S. As an economic test, shocks to pr are priced in the cross-section of stocks, consistent with ICAPM. Our measure of expected return declines during monetary expansions, and varies strongly with the conditions of macroeconomy, financial intermediaries, and sentiment.

Presentations (scheduled): Econometric Society (North America), FMA, French Finance Association 

with Lin William Cong, Neng Wang, Mar 2018 New! 

We provide a dynamic model of cryptocurrencies and tokens that serve as means of payment among (blockchain-based) platform users. Introducing tokens capitalizes future growth because the expected technological progress and popularity of the platform render tokens an attractive store of value, inducing further adoption. We derive the unique equilibrium in continuous-time formulation, and characterize, in addition to the contemporaneous complementarity of users' adoption decisions, an inter-temporal feedback from the interaction between user-base dynamics and token price. The token price depends on user base, platform productivity, agents' transaction needs, and their expectation of token appreciation. We also show that native tokens not only accelerate adoption but also moderate user-base fluctuation to enhance welfare. Our model sheds light on the broad issue of asset pricing with user-base externalities.