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.     
SSRN link
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

Feb 2018  

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.

SSRN link

Presentations:  European Winter Finance Summit (Sudipto Bhattacharya Memorial Prize),                                WFA (Western Finance Association),  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 Chen Wang, Jun 2018  New!

Abstract: Big data creates a division of knowledge - asset managers use big data and professional techniques to estimate the probability distribution of asset returns, while investors face model uncertainty. Model uncertainty offers a new perspective to understand delegation, which, for example, reconciles the growth of asset management industry and its lack of convincing performance. Delegation fundamentally transforms the role of model uncertainty in asset pricing by inducing a hedging motive of investors that increases with the level of delegation. It explains patterns ("anomalies") in the cross-section of asset returns and offers practical guidance to identify alpha that is robust to the rise of arbitrage capital. We provide evidence that supports the assumptions and predictions of our theory.

SSRN link
Presentations:  CEPR ESSFM Gerzensee, Geneva Workshop on Financial Stability in a New Era


 with Edward Denbee, Christian Julliard, Kathy Yuan, Jun 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.

SSRN link  

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


with Lin William Cong, Neng Wang, May 2018 New Version! 

We provide a dynamic asset-pricing model of (crypto-) tokens on (blockchain-based) platforms. Tokens intermediate peer-to-peer transactions, and their trading creates inter-temporal complementarity among users and generates a feedback loop between token valuation and adoption. Consequently, tokens capitalize future platform growth, accelerate adoption, and reduce user-base volatility. Equilibrium token price increases non-linearly in platform productivity, user heterogeneity, and endogenous network size. Consistent with evidence, the model produces explosive growth of user base after an initial period of dormant adoption, accompanied by a run-up of token price volatility.

SSRN link

Presentations: CEPR ESSFM Gerzensee, Stanford SITE, Finance Theory Group  (FTG),  Chicago Booth, Luxembourg Asset Management, CityU HK Finance Conf,  3rd Rome Junior Finance Conf, Emerging Trends in Entrepreneurial Finance (Best Paper Award), 2nd Private Markets Research Conference, JOIM Conf on FinTech, Finance UC International Conference, Norwegian School of Economics, LeBow/GIC/FRB Conf on Cryptocurrency, Shanghai Forum 


with Chen Wang, Jun 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. Using an exponential-affine model, we show a one-to-one mapping between pr and the expected market return when the expectation of future cash flow is transient. Moreover, we find that 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.

SSRN link

Presentations: Econometric Society (North America), Northern Finance Association (NFA)


with Yi Huang, Hongzhe Shan, Jun 2018 New! 

Abstract: This paper provides the first evidence on how fintech powered by big data impacts firm dynamics. With comprehensive data from Alibaba, the largest e-commerce platform and the largest fintech lender in China, we estimate the causal impact of fintech credit on the size distribution of small businesses. We find that platform credit promotes firm selection – credit leads to stronger growth of market share for e-commerce merchants that are larger and more reputable. To unveil the credit transmission mechanism, we examine the impact of credit under different industry conditions and the impact on product pricing. We also document a dynamic effect: firms’ credit score, assigned by platform’s proprietary algorithm, is highly correlated with their market share and reputation, so a feedback loop arises between firms’ market status and fintech credit that speeds up the process of firm selection in this fast growing entrepreneurial space.

Presentations: FDIC Annual Bank Research Conference