Publications
The Narrow Channel of Quantitative Easing: Evidence from YCC, Down Under
with Jonathan Wright | Journal of Finance, accepted
Abstract | Paper
We study the recent Australian experience with yield curve control (YCC) of government bonds as perhaps the best evidence of how this policy might work in other developed economies. We interpret the evidence with a simple model in which YCC affects prices of both government and other bonds via “broad” transmission channels, but only government bond prices through “narrow” liquidity channels. YCC seemingly worked well in 2020 while the market expected short rates to stay at zero for long. But as the global recovery and inflation gained momentum in 2021, liftoff expectations moved up, the Reserve Bank of Australia purchased most of the outstanding amount of the targeted government bond, and its yield dislocated from other financial market instruments. The model and empirical evidence point to narrow transmission channels playing more prominent roles than broad channels considered in prior studies of quantitative easing (QE), such as portfolio balance effects and signaling about short term rates. We argue that asset-specific narrow channels may be primary transmission mechanisms of quantity-based QE policies as well.
Mortgage-Backed Securities
with Andreas Fuster and James Vickery | Research Handbook of Financial Markets, 2023, Edward Elgar
Abstract | Paper
This paper reviews the mortgage-backed securities (MBS) market, with a particular emphasis on agency residential MBS in the United States. We discuss the institutional environment, security design, MBS risks and asset pricing, and the economic effects of mortgage securitization. We also assemble descriptive statistics about market size, growth, security characteristics, prepayment, and trading activity. Throughout, we highlight insights from the expanding body of academic research on the MBS market and mortgage securitization.
The Economics of Bank Supervision
with Thomas Eisenbach and Robert Townsend | Journal of Finance, 2022, Vol. 77, no. 3
Abstract | Paper
We use unique data on work hours of Federal Reserve bank supervisors and a structural model to provide new insights on the impact of bank supervision, the efficiency of the allocation of supervisory resources, and the shape of supervisory preferences. We find that supervision has an economically large effect in lowering bank distress and that the supervisory cost function displays large economies of scale with respect to bank size. Estimated supervisory preferences weight larger banks more than proportionally, consistent with macro-prudential objectives, and especially so after 2008, when resources were reallocated to large banks. This reallocation lowered risk at large banks less than it increased risk at small banks. We show evidence of frictions that prevent an efficient allocation of resources both within and across Federal Reserve districts. Model counterfactuals quantify the benefits of reducing these frictions, especially for the riskiest banks.
Rate-Amplifying Demand and the Excess Sensitivity of Long-Term Rates
with Sam Hanson and Jonathan Wright | Quarterly Journal of Economics, 2021, Vol. 136, no. 3
Abstract | Paper
Long-term nominal interest rates are known to be highly sensitive to high-frequency (daily or monthly) movements in short-term rates. We find that, since 2000, this high-frequency sensitivity has grown even stronger in U.S. data. By contrast, the association between low-frequency changes (at 6- or 12-month horizons) in long- and short-term rates, which was also strong before 2000, has weakened substantially. This puzzling post-2000 pattern arises because increases in short rates temporarily raise the term premium component of long-term yields, leading long rates to temporarily overreact to changes in short rates. The frequency-dependent excess sensitivity of long-term rates that we observe in recent years is best understood using a model in which (i) declines in short rates trigger "rate-amplifying shifts" in investor demand for long-term bonds and (ii) the arbitrage response to these demand shifts is slow. We study, both theoretically and empirically, how such rate-amplifying demand can be traced to mortgage refinancing activity, investors who overextrapolate recent changes in short rates, and investors who "reach for yield" when short rates fall. We discuss the implications of our findings for the validity of event-study methodologies and for the transmission of monetary policy.
Taking Orders, Taking Notes: Dealer Information Sharing in Treasury Auctions
with Nina Boyarchenko and Laura Veldkamp | Journal of Political Economy, 2021, vol. 129, no. 2
Abstract | Paper
The use of order flow information by financial firms has come to the forefront of the regulatory debate. A central question is: Should a dealer who acquires information by taking client orders be allowed to use or share that information? We explore how information sharing affects dealers, clients and issuer revenues in U.S. Treasury auctions. Because one cannot observe alternative information regimes, we build a model, calibrate it to auction results data, and use it to quantify counter-factuals. The model's key force is that sharing information reduces uncertainty about future value. With less uncertainty, risk-averse bidders bid more. For investors, the welfare effects of information sharing depend on how information is shared and whether it increases or decreases asymmetry. The model shows that investors can benefit when dealers share information with each other, not when they share more with clients.
Understanding Mortgage Spreads
with Nina Boyarchenko and Andreas Fuster | Review of Financial Studies, 2019, vol. 32, no. 10
Abstract | Paper
Most mortgages in the U.S. are securitized in agency mortgage-backed securities (MBS). Yield spreads on these securities are thus a key determinant of homeowners’ funding costs. We study variation in MBS spreads over time and across securities, and document a cross-sectional smile pattern in MBS spreads with respect to the securities’ coupon rates. We propose non-interest-rate prepayment risk as a candidate driver of MBS spread variation and present a new pricing model that uses “stripped” MBS prices to identify the contribution of this prepayment risk to the spread. The pricing model finds that the smile can be explained by prepayment risk, while the time-series variation is mostly accounted for by a non-prepayment risk factor that co-moves with MBS supply and credit risk in other fixed income markets. We use the pricing model to study the MBS market response to the Fed’s large-scale asset purchase program and to interpret the post-announcement divergence of spreads across MBS.
Credit Supply and the Rise in College Tuition: Evidence from the Expansion in Federal Student Aid Programs
with Taylor Nadauld and Karen Shen | Review of Financial Studies, 2019, vol. 32, no. 2 (lead article)
Abstract | Paper | 2020 Michael J. Brennan Award, best paper in RFS | Testimony before the U.S. House of Representatives
We study the link between the student credit expansion of the past fifteen years and the contemporaneous rise in college tuition. To disentangle simultaneity issues, we analyze the effects of increases in federal student loan caps using detailed student-level financial data. We find a pass-through effect on tuition of changes in subsidized loan maximums of about 60 cents on the dollar, and smaller but positive effects for unsubsidized federal loans. The subsidized loan effect is most pronounced for more expensive degrees, those offered by private institutions, and for two-year or vocational programs.
Supervising Large, Complex Financial Institutions: What Do Supervisors Do?
with Thomas Eisenbach, Andrew Haughwout, Beverly Hirtle, Anna Kovner and Matt Plosser | Economic Policy Review, 2017, vol. 2
Abstract | Paper
The supervision of large, complex financial institutions is one of the most important, but least understood, activities of the Federal Reserve. Supervision entails monitoring and oversight to assess whether firms are engaged in unsafe or unsound practices, and to ensure that firms take appropriate action to correct such practices. It is distinct from regulation, which involves the development and promulgation of the rules under which firms operate. This article brings greater transparency to the Federal Reserve’s supervisory activities by considering how they are structured, staffed, and implemented on a day-to-day basis at the Federal Reserve Bank of New York as part of the broader Systemwide supervisory program. The goal of the article is to generate insight into what supervisors do and how they do it. While the authors do not undertake to evaluate the effectiveness of the activities they describe, they note that understanding how supervision works is a critical precursor to determining how to measure its impact.
The Pre-FOMC Announcement Drift
with Emanuel Moench | Journal of Finance, 2015, vol. 70, no. 1
Abstract | Paper | 2015 Amundi Smith Breeden Prize, best paper in JF
We document large average excess returns on U.S. equities in anticipation of monetary policy decisions made at scheduled meetings of the Federal Open Market Committee (FOMC) in the past few decades. These pre-FOMC returns have increased over time and account for sizable fractions of total annual realized stock returns. While other major international equity indices experienced similar pre-FOMC returns, we find no such effect in U.S. Treasury securities and money market futures. Other major U.S. macroeconomic new announcements also do not give rise to pre-announcement excess equity returns. Pre-FOMC returns are higher in periods when the slope of the Treasury yield curve is low, implied equity market volatility is high, and when past pre-FOMC returns have been high. We discuss challenges explaining these returns with standard asset pricing theory
The Revolving Door and Worker Flows in Banking Regulation
with Amit Seru and Francesco Trebbi | Journal of Monetary Economics, 2014, vol. 17, no. 32
Abstract | Paper
Drawing on a large sample of publicly available curricula vitae, this paper traces the career transitions of federal and state U.S. banking regulators and provides basic facts on worker flows between the regulatory and private sectors resulting from the revolving door. We find strong countercyclical net worker flows into regulatory jobs, driven largely by higher gross outflows into the private sector during booms. These worker flows are also driven by state-specific banking conditions as measured by local banks’ profitability, asset quality, and failure rates. The regulatory sector seems to experience a retention challenge over time, with shorter regulatory spells for workers, and especially those with higher education. Evidence from cross-state enforcement actions of regulators shows that gross inflows into regulation and gross outflows from regulation are both higher during periods of intense enforcement, though gross outflows are significantly smaller in magnitude. These results appear inconsistent with a “quid pro quo” explanation of the revolving door but consistent with a “regulatory schooling” hypothesis.
Inconsistent Regulators: Evidence from Banking
with Sumit Agarwal, Amit Seru and Francesco Trebbi | Quarterly Journal of Economics, 2014, vol. 129, no. 2
Abstract | Paper
We find that regulators can implement identical rules inconsistently due to differences in their institutional design and incentives and this behavior adversely impacts the effectiveness with which regulation is implemented. We study supervisory decisions of U.S. banking regulators and exploit a legally determined rotation policy that assigns federal and state supervisors to the same bank at exogenously fixed time intervals. Comparing federal and state regulator supervisory ratings within the same bank, we find that federal regulators are systematically tougher, downgrading supervisory ratings almost twice as frequently as state supervisors. State regulators counteract these downgrades to some degree by upgrading more frequently. Under federal regulators, banks report higher fraction of nonperforming loans, more delinquent loans, higher regulatory capital ratios, and lower returns on assets. Leniency of state regulators relative to their federal counterparts is related to costly consequences and likely proxies for delayed corrective actions—more lenient states have higher bank-failure rates, lower repayment rates of government assistance funds, and more costly bank resolutions. Moreover, relative leniency of state regulators at the bank level predicts the bank's subsequent likelihood of severe distress. The discrepancy in regulator behavior arises because of differences in how much regulators care about the local economy as well as differences in human and financial resources involved in implementing the regulation. There is no support for the corruption hypothesis, which includes “revolving doors” as a reason for leniency of state regulators. We conclude by discussing broader applicability of our findings as well as implications of our work for the design of banking regulators in the U.S. and Europe.
The Rising Gap Between Primary and Secondary Mortgage Rates
with Andreas Fuster, Laurie Goodman, Lauren Madar, Linsey Molloy and Paul Willen | Economic Policy Review, 2013, vol. 19
Abstract | Paper
While mortgage rates reached historic lows during 2012, the spread between primary and secondary rates rose to very high levels. This trend reflected a number of factors that potentially affected mortgage originator costs and profits and restrained the pass-through from lower secondary rates to borrowers’ funding costs. This article describes the mortgage origination and securitization process and the way in which originator profits are determined. The authors calculate a series of originator profits and unmeasured costs (OPUCs) for the period 1994 to 2012, and show that these OPUCs increased significantly between 2008 and 2012. They also evaluate the extent to which some commonly cited factors, such as changes in loan putback risk, mortgage servicing rights values, and pipeline hedging costs contributed to the rise in OPUCs. Although some costs of mortgage origination may have risen in recent years, a large component of the rise in OPUCs remains unexplained, pointing to increased profitability of originations. The authors conclude by discussing possible drivers of the rise in profitability, such as capacity constraints and originators’ pricing power resulting from borrowers’ switching costs.
Domestic Political Survival and International Conflict: Is Democracy Good for Peace?
with Sandeep Baliga and Tomas Sjostrom | Review of Economic Studies, 2011, vol. 78, no. 2
Abstract | Paper
We build a game-theoretic model where aggression can be triggered by domestic political concerns as well as the fear of being attacked. In the model, leaders of full and limited democracies risk losing power if they do not stand up to threats from abroad. In addition, the leader of a fully democratic country loses the support of the median voter if he attacks a non-hostile country. The result is a non-monotonic relationship between democracy and peace. Using Polity data, we classify countries as full democracies, limited democracies, and dictatorships. For the period 1816–2000, Correlates of War data suggest that limited democracies are more aggressive than other regime types, including dictatorships, and not only during periods when the political regime is changing. In particular, a dyad of limited democracies is more likely to be involved in a militarized dispute than any other dyad (including “mixed” dyads, where the two countries have different regime types). Thus, while full democratization might advance the cause of peace, limited democratization might advance the cause of war. We also find that as the environment becomes more hostile, fully democratic countries become more aggressive faster than other regime types.
Permanent Working Papers
Parsing the Content of Bank Supervision
with Beverly Hirtle and Paul Goldsmith-Pinkham | 2016 |
Abstract | Paper
We measure bank supervision using the database of supervisory issues, known as matters requiring attention or immediate attention, raised by Federal Reserve examiners to banking organizations. The volume of supervisory issues increases with banks’ asset size, especially for the largest and most complex banks, and decreases with profitability and the quality of the loan portfolio. Stressed banks are faster at resolving issues, but all else equal, resolving new issues takes longer the more issues a bank faces, which may suggest capacity constraints in addressing multiple supervisory issues. Using computational linguistic methods on the text of the issue description, we define five categorical issue topics. The subset of issues related to capital levels and loan portfolio are the most consequential in terms of regulatory rating downgrades and are directly related to changes in banks’ balance sheet characteristics and profitability. Other issues appear to reflect soft information and are less correlated with bank observables. By categorizing questions asked by analysts at banks’ quarterly earnings calls using the same linguistic approach, we find that market monitors raise issues similar to those of supervisors when the issues are related to hard information (such as loan quality or capital) and public supervisory assessment programs.
Measuring Central Bank Communication: An Automated Approach with Application to FOMC Statements
with Francesco Trebbi | 2011
Abstract | Paper | Online Appendix
We present a new method to measure central bank communication and apply it to statements by the Federal Open Market Committee. The measures are intuitive and capture significant information about future rate decisions by the Federal Reserve. We find that longer-dated Treasury yields mainly react to changes in communication around announcements. In lower frequency data, changes in the statements lead policy rate decisions by more than a year, and are a significant determinant of longer-dated Treasury yields. The statements contain information regarding both the predicted and the residual component of a Taylor rule model, and lead the residual component.
Resuscitating Time-to-build | 2007
Abstract | Paper
A novel specification of the time-to-build (TTB) assumption is presented where firms invest in many projects that have complementarities, and the duration of the investment projects is uncertain. The model yields to a gradual (hump-shaped) response of investment to shocks, and it is shown to be equivalent, up to first-order linearization, to investment adjustment cost models where the cost of adjustment directly depends on the change in investment levels. The paper discusses how the new TTB specification is consistent with empirical features of investment decisions both at the aggregate and more disaggregated levels.
