Working papers
A Structural Model of Interbank Network Formation and Contagion
with Jamie Coen (Imperial College)
R&R Journal of Financial Economics
We study the equilibrium relationship between interbank exposures and bank default risk: how exposures affect risk, and how banks account for this when forming the exposures network. We leverage novel data on aggregate interbank exposures across multiple types of financial instrument. We find that contagion is material (risk would be 0.2% higher if exposures increased by 1%) but that banks account for this in equilibrium (risk would be 10% higher if they did not). We also find systematic heterogeneity in contagion based on the characteristics of the banks involved, with implications for the identification of systemically important banks and regulation.
Collateral Demand in Wholesale Funding Markets
with Jamie Coen (Imperial College) and Anne-Caroline Huser (Bank of England)
R&R Review of Financial Studies
Repo markets are systemically important funding markets, but are also used by firms to obtain the assets provided as collateral. Do these two functions complement each other? We build and estimate a model of repo trade between heterogeneous firms, and find that the answer is no: volumes and gains to trade would both be higher absent collateral demand. This is because on average the firms that need funding are also those that value the collateral to speculate or hedge interest rate risk. These results have implications for policies that affect collateral demand in repo markets, including rules on short selling.
Information Loss during Financial Crises
R&R Journal of Financial and Quantitative Analysis
Financial crises lead to entry and exit, and so change the composition of the mutual fund industry: entrants may be higher quality than exiting funds (a cleansing effect that improves aggregate surplus), but they have no returns history and so investors have less precise beliefs about their ability (an information loss effect that harms surplus). I quantify this trade-off by setting out and structurally estimating a model of investor learning and fund turnover. I find that crises have negative persistent effects in the short-term as information loss dominates cleansing, but this reverses over time as the information loss channel decays.
A Structural Model of Liquidity in Over-the-Counter Markets
with Jamie Coen (Imperial College)
We study how firm heterogeneity determines liquidity in over-the-counter markets. Using a rich dataset on trading in the secondary market for sterling corporate bonds, we build and estimate a flexible model of search and trading in which firms have heterogeneous search costs. We show that the 8% most active traders supply as much liquidity as the remaining 92%. Liquidity is thus vulnerable to shocks that restrict active traders’ willingness to trade: if the 4% most active traders stop trading, liquidity falls by over 60%. Bank capital regulation reduces the willingness of these active traders to hold assets and thus reduces liquidity. However, trader search, holdings and intermediation respond endogenously to reduce the welfare costs of regulation by 30%. These costs are greater in a stress, when these margins of adjustment are constrained. The introduction of trading platforms, which homogenise the ability of traders to trade frequently, improves aggregate welfare but harms the most active traders who currently profit from supplying liquidity.
patrick-coen.com 