Working Papers

Sovereign Bond Purchases and Rollover Crises

November 23. Paper.

This paper proposes a theory of large-scale government bond purchases by central banks in an environment with endogenous information acquisition. Information acquisition by private investors lowers risk premia by reducing uncertainty, but also makes prices more sensitive to new information. This can drive the sovereign into costly roll-over crises. Asset purchases by the central bank discourage private information acquisition, impairing price informativeness. This, however, points to a benefit of such large scale programs: by implementing purchases, the central bank can avoid the occurrence of roll-over crises in the event of bad news, generating large welfare gains. A key property of the model is that substantial purchases may be required, while small interventions have ambiguous welfare consequences. When the sovereign expects the central bank to carry such programs, it leads to excessive indebtedness, forcing the central bank to run an inflated balance sheet to avoid roll-over crises.

Dollar Debt and the Inefficient Global Financial Cycle

July 23. Paper.

This paper proposes a tractable model of the Global Financial Cycle and study its welfare implications for emerging market economies (EMEs). When local firms issue debt denominated in dollars, central banks must increase their policy rate as the U.S. tightens in order to offset balance sheet effects stemming from the depreciation of their currency. When global financial markets are imperfect, this synchronized policy response has negative spillovers: all individual countries seek to attract capital inflows at the expense of one another, exacerbating the Global Financial Cycle. This congestion externality requires further tightening and results in inefficiently low levels of output and employment in EMEs, and generates gains from coordination. On the contrary, discouraging debt issuance in dollars through macroprudential policy has positive spillovers, and does not necessarily require coordination between EMEs. Its optimal use dampens the Global Financial Cycle and its inefficiencies.

Optimal Policy for Behavioral Financial Crises

November 23. Paper, Slides. R&R, Journal of Financial Economics

Should policymakers adapt their macroprudential and monetary policies when the financial sector is vulnerable to belief-driven boom-bust cycles? I develop a model in which financial intermediaries are subject to collateral constraints, and that features a general class of deviations from rational expectations. I show that distinguishing between the drivers of behavioral biases matters for the precise calibration of policy: when biases are a function of equilibrium asset prices, as in return extrapolation, new externalities arise, even in models that do not have any room for policy in their rational benchmark. These effects are robust to the degree of sophistication of agents regarding their future biases. I show how time-varying leverage, investment and price regulations can achieve constrained efficiency. Importantly, greater uncertainty about the extent of behavioral biases in financial markets reinforces incentives for preventive action.

Expectations and Learning from Prices

with Francesca Bastianello. January 24. Paper, Appendix. Accepted, Review of Economic Studies

We study mislearning from equilibrium prices, and contrast this with mislearning from exogenous fundamentals. We micro-found mislearning from prices with a psychologically founded theory of "Partial Equilibrium Thinking" (PET), where traders learn fundamental information from prices, but fail to realize others do so too. PET leads to over-reaction, and upward sloping demand curves, thus contributing to more inelastic markets. The degree of individual-level over-reaction, and the extent of inelasticity varies with the composition of traders, and with the informativeness of new information. More generally, unlike mislearning from fundamentals, mislearning from prices i) generates a two-way feedback between prices and beliefs that can provide an arbitrarily large amount of amplification, and ii) can rationalize both over-reaction and more inelastic markets. The two classes of biases are not mutually exclusive. Instead, they interact in very natural ways, and mislearning from prices can vastly amplify mislearning from fundamentals.

Partial Equilibrium Thinking, Extrapolation, and Bubbles

with Francesca Bastianello. December 23. Paper, Supplementary Material.

We develop a dynamic theory of ``Partial Equilibrium Thinking” (PET), which micro-founds time-varying price extrapolation. Extrapolative beliefs are present at all times, but only sometimes manifest themselves in explosive ways. Consistent with the Kindleberger (1978) narrative of bubbles, we distinguish between normal times shocks and ``displacement shocks.” In normal times, PET generates constant extrapolation and momentum. By contrast, following a displacement shock that increases uncertainty, PET leads to stronger and time-varying extrapolation, triggering bubbles and endogenous crashes. Our theory sheds light on both normal times market dynamics and the Kindleberger (1978) narrative of bubbles within a unified framework.