Ye Li

with Yi Li, Huijun Sun, Nov. 2022, SSRN
Abstract: The money view of banking emphasizes deposits as part of money supply that central banks can manage to influence the macroeconomy (Friedman and Schwartz, 1963). The credit view focuses instead on the asset side of bank balance sheets and proposes a bank lending channel (Bernanke, 1983). In this paper, we show that the monetary role of deposits is in fact key to the credit channel as it connects monetary base and bank lending. As deposits circulate as means of payment, settlement reshuffles liquidity (reserves) among banks. The network topology of such reserve flows determines banks' exposure to liquidity risk and their willingness to invest in illiquid loans. We develop a model to capture this mechanism. Our structural estimation explores transaction-level data and characterizes a money multiplier that emerges from the liquidity percolation in payment system. Payment network generates liquidity externalities of banks' lending decisions and amplifies the volatility of credit supply. A small set of banks are critically positioned in the network and contribute disproportionately to the credit cycle.
Selected presentations: Advances in Macro-Finance Tepper-LAEF Conference, Boston College (Carroll), BSE (Barcelona School of Economics) Summer Forum, CESifo, European Banking Center Network Conference at Tilburg, ECB research seminar, European Finance Association, Frankfurt School of Finance & Management, Imperial College London finance seminar, NYU Econ/Stern macro seminar, Stanford University finance seminar, UCLA Anderson finance seminar, UNC Junior Roundtable, University of Zurich research seminar

Conditional accept at the American Economic Review, Nov. 2022, SSRN
Abstract: Intangible-intensive firms in the U.S. hold an enormous amount of liquid assets that are in fact short-term debts issued by financial intermediaries. This paper builds a macro-finance model that captures this structure. A self-perpetuating savings glut emerges in equilibrium. As intangibles become increasingly important for production, firms hoard more liquidity to finance investments in intangibles with limited pledgeability. The resulting low interest rates induce intermediaries to increase leverage and bid up asset prices, which in turn encourages firms to invest more and hoard even more liquidity to fund expansion. Along these secular trends, endogenous risk accumulates in the financial system.
Selected presentations: CEPR ESSFM Gerzensee, Cornell Johnson, CUHK, EFA (European Finance Association), European Winter Finance Summit (Best Paper Award), HKUST Macro Workshop, Temple U Fox, U Calgary Haskayne, WFA

R&R at the Journal of Finance, Nov. 2022, SSRN
Abstract: Under financial constraints, firms hold liquid assets in anticipation of investment needs. Financial intermediaries supply liquid securities in the form their short-term debts. Endogenous liquidity creation stimulates investment and economic growth but generates intermediary leverage cycle that destabilizes the economy. Introducing government debt as an alternative source of liquidity is a double-edged sword. On the one hand, firms hold more liquidity in every state of the economy. On the other hand, by crowding out intermediaries' profits from liquidity provision, government debt induces intermediaries to reach for yield via procyclical risk-taking. As a result, the stationary (long-run) probability distribution tilts towards crisis states where intermediaries are undercapitalized and supply less liquidity. The latter force dominates, when public liquidity cannot satiate firms' liquidity demand and intermediaries are still the marginal liquidity suppliers. Contrary to the literature, this paper demonstrates an overall negative impact of public liquidity on both long-run growth and financial stability.
Selected presentations: Becker Friedman Institute (U Chicago), CEPR Credit Cycle, U Chicago (Booth), Finance Theory Group Summer Conference, Columbia Business School (Finance), ECB, Georgetown (McDonough), European Finance Association (EFA), Imperial College Business School, Johns Hopkins (Carey), LSE (finance), Northwestern University (Kellogg), New York Fed, Ohio State University (Fisher), Oxford Financial Intermediation Theory Conference, Stanford SITE, University of Southern California (Marshall), U Penn (Wharton)

with Patrick Bolton, Neng Wang, and Jinqiang Yang, Sep. 2021, R&R at the Journal of Finance, NBER, SSRN
Abstract: We propose a dynamic theory of banking where the role of deposits is akin to that of productive capital in the classical q-theory of investment. As a cheap source of leverage, deposits typically create value for banks, but the marginal q of deposits can be negative. Deposit accounts commit banks to accept any inflows and outflows, so that banks cannot perfectly control leverage. Such uncertainty destroys value when banks have insufficient equity capital to buffer shocks. Our model lends itself to a re-evaluation of leverage regulations and offers new perspectives on banking in a low interest-rate environment.
Selected presentations: 2022: European Winter Finance Summit, Financial Intermediation Research Society (FIRS) Conference; 2021: Cambridge Corporate Finance Theory, CICF, CICM, EFA (European Finance Association), Federal Reserve Board, International Association of Deposit Insurers (IADI) Conference, NBER Summer Institute, MFA, NFA, Short-Term Funding Markets, SED (Society for Economic Dynamics), Rochester, U Washington; 2020: BI-SSE Conference on Asset Pricing & Financial Econometrics, CESifo Macro Money & International Finance, Fudan U, OSU Fisher, Washington University in St. Louis (WUSTL) Corporate Finance Conference

with Wenhao Li, Nov. 2021, R&R at the Review of Economic Studies SSRN

Abstract: In crises, low-quality firms face greater financial shortfalls and invest less than high-quality firms. Public liquidity support preserves the overall production capacity but dampens the cleansing effects of crises on firm quality. The trade-off between quantity and quality determines the optimal size of intervention. Policy distortions are self-perpetuating: A downward bias in quality necessitates interventions of greater scales in future crises. Distortions are amplified by low-quality firms’ expectations of liquidity support and overinvestment pre-crisis. Finally, the optimal intervention is larger and distortionary effects stronger in a low interest rate environment where low yields on precautionary savings discourage firms from self-insurance.

Selected Presentations: 2023: AFA; 2022: BSE (Barcelona School of Economics) Summer Forum, HEC-McGill Winter Finance Workshop, MFA; 2021: Colorado Finance Summit, FTG (Finance Theory Group), IMF, Liquidity in Macroeconomics Workshop, Paris December Finance Meeting, SAIF, SFS Cavalcade North America, USC Marshall

with Edward Denbee, Christian Julliard, Kathy Yuan, Journal of Financial Economics, Volume 141, Issue 3, Sep. 2021 (Lead Article), JFE, SSRN
Abstract: Using a structural model, we estimate the liquidity multiplier of an interbank network and banks’ contributions to systemic risk. To provide payment services, banks hold reserves. Their equilibrium holdings can be strategic complements or substitutes. The former arises when payment velocity is high and payments begets payments. The latter prevails when the opportunity cost of liquidity is large, incentivizing banks to borrow neighbors’ reserves instead of holding their own. Consequently, the network can amplify or dampen individual shocks. Empirically, network topology explains cross-sectional heterogeneity in banks’ contribution to systemic risks while changes in the equilibrium type drive the time-series variation.
Selected presentations: Bank of Canada, Bank of England, Fed/OFR Financial Stability Conference, MFS (Macro Finance Society), LSE, NBER Summer Institute, OSU Fisher, Short-Term Funding Markets, Stockholm School of Economics, WFA; Grant: Foundation Banque de France Research Grant

with Lin Will Cong, Neng Wang, Review of Financial Studies, Volume 34, Issue 3, Mar. 2021 (Editor's Choice), RFS, SSRN, NBER
Abstract: We develop a dynamic asset-pricing model of cryptocurrencies/tokens that allow users to conduct peer-to-peer transactions on digital platforms. The equilibrium value of tokens is determined by aggregating heterogeneous users' transactional demand rather than discounting cashflows as in standard valuation models. Endogenous platform adoption builds upon user network externality and exhibits an $S$-curve - it starts slow, becomes volatile, and eventually tapers off. Introducing tokens lowers users' transaction costs on the platform by allowing users to capitalize on platform growth. The resulting intertemporal feedback between user adoption and token price accelerates adoption and dampens user-base volatility.
Selected presentations: Ant Financial (Alibaba Group), Atlanta Fed, CEPR ESSFM Gerzensee, Chicago Booth, CKGSB, Finance UC Chile, FTG (Finance Theory Group), Georgetown McDonough, RCFS/RAPS Conf. at Baha Mar, SEC, Stanford SITE, UT Dallas Fall Finance Conf., Tsinghua, U Washington Foster, U Zurich/ETH; Awards: AAM-CAMRI-CFA Institute Prize in Asset Management, CME Best Paper Award (Emerging Trends in Entrepreneurial Finance)

with Lin W. Cong, Neng Wang, Journal of Financial Economics, Volume 144, Issue 3, Jun. 2022, JFE, SSRN, NBER
Abstract: We develop a dynamic model of platform economy where tokens serve as a means of payments among platform users and are issued to finance investment in platform productivity. Tokens are optimally issued to reward platform owners when the productivity-normalized token supply is low and burnt to boost the franchise value when the productivity-normalized normalized supply is high. Although token price is determined in a liquid market, the platform's financial constraint generates an endogenous token issuance cost, causing underinvestment through the conflict of interest between insiders (platform owners) and outsiders (users). Blockchain technology mitigates underinvestment by addressing the platform's time-inconsistency problem.
Selected presentations: AFA 2020, CEPR/ABFER/CUHK Financial Economics Symposium, CEPR ESSFM Gerzensee, Cleveland Fed/OFR Conf., Erasmus Liquidity Conference, Chicago Financial Institutions Conference, Macro Finance Society (at USC), Rome Junior Finance Conference

with Yi Li, Dec. 2021, SSRN
Abstract: Deposits finance bank lending and serve as means of payment for bank customers. Under uncertain payment flows, deposits are debts with random maturities. Payment outflows drain reserves, and the risk is most prominent when funding markets are under stress and banks are unable to smooth out payment shocks. We provide the first evidence on the negative impact of payment risk on bank lending, bridging the literatures on payment systems and credit supply. An interquartile increase in payment risk is associated with a decline in loan growth rate that is 10% of standard deviation. Our findings are stronger in times of funding stress and robust across banks of different sizes and loans of long and short maturities. Banks with higher payment risk raise deposit rates to expand customer base and internalize payment flows. Finally, we show that payment risk dampens the bank lending channel of monetary policy transmission.
Selected presentations: 2022: Adam Smith Workshop at INSEAD, BSE (Barcelona School of Economics) Summer Forum, Chicago Fed, FDIC, Federal Reserve Board, Northeastern University Finance Conference, Northeastern University Finance Conference, OCC Symposium on Systemic Risk and Stress Testing, SFS Cavalcade North America, University of Illinois at Urbana-Champaign (UIUC) finance seminar

with Simon Mayer, Dec. 2021, SSRN
Abstract: Stablecoins are at the center of debate surrounding decentralized finance. We develop a dynamic model to analyze the instability mechanism of stablecoins, the complex incentives of stablecoin issuers, and regulatory proposals. The model rationalizes a variety of stablecoin management strategies commonly observed in practice and characterizes an instability trap: Stability lasts for long time, but once debasement happens, price volatility persists. Capital requirement improves price stability but fails to eliminate debasement. Restricting the riskiness of reserve assets can surprisingly destabilize price. Finally, data privacy regulation has an unintended benefit of reducing the price volatility of stablecoins issued by data-driven platforms.
Selected presentations: 2022: ABFER, AFA, GSU-RFS Fintech Conferecen, MFA, Purdue Fintech Conference, Utah Winter; 2021: Bank of Finland/BIS Economics of Payments, CESifo Macro Money & International Finance, CICF, Duke Fuqua, ECB Money Market Conf., Econometric Society, Hogeg Blockchain Institute Conf., Purdue Fintech Conference, Stanford SITE, U Amsterdam

with Chen Wang, SSRN
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.
Selected presentations: HKUST Finance Symposium, Paris December Meeting (Best Paper Award), RCFS/RAPS Conf. at Baha Mar, UT Dallas Fall Finance Conf., Econometric Society, NFA, Orebro Workshop on Predicting Asset Returns

with Chen Wang, SSRN
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.
Selected presentations: ASU Sonoran Winter Conf., CEPR ESSFM Gerzensee, CUHK, European Winter Finance Summit, INSEAD, Stanford SITE, U Zurich