WORKING PAPERS

“Run-prone Banking and Asset Markets,” ECB Working Paper No 845, December 2007. An earlier version: "Financial Deepening and Bank Runs," Working Paper 05-07, Center for Analytic Economics, Cornell University, Ithaca, May 2005.

I analyze the role that asset markets play in the performance and stability of the run-prone banking sector. Banks insure consumers against privately observed liquidity shocks. Asset market investments insure consumers against losses from bank runs. If the probability of a run is small, then banks specialize fully into the provision of liquidity insurance: They provide a higher degree of liquidity insurance when compared to the economy with banks alone. If the probability of a run is high, consumers prefer to invest solely through the asset market. Insurance against runs provided by the market investment reduces consumers' incentives to run. Increased provision of liquidity insurance by banks has the opposite effect. I derive conditions under which the latter effect dominates and the probability of a run is higher than with banks alone.

“Public Information and Monetary Policy,” (with Cyril Monnet, FRB Philadelphia and Ted Temzelides, University of Pittsburgh), June 2007. -UPDATED DECEMBER 2007-

We study the nature of monetary policy in a model where uncertainty can lead to a discrepancy between economic agents' beliefs and true fundamentals. Monetary policy transmits information about fundamentals. The public nature of this information can help agents to coordinate their decisions. This comes at a cost, however, since monetary policy may lead the private sector to coordinate on the wrong fundamentals and it may result in inflation. We discuss conditions under which monetary policy will be unambiguously welfare-improving. We formalize the notion that monetary policy is equivalent to information revelation by the central bank, and offer an information-based (as opposed to the standard liquidity-based) argument for why higher nominal rate hikes occur less frequently than lower ones.

“Financial System in Development: Implications for the Liquidity Provision,” May 2005.

I study liquidity provision by a financial system consisting of run-prone banks and an asset market which is illiquid due to limited market participation. I find that for low probabilities of a run, banks enhance the supply liquidity to the asset market and asset prices are higher than in the economy with asset markets alone. This enables consumers to economize on liquid asset holdings (Diamond 1997). By contrast, if there is a run, banks need to liquidate their portfolio holdings by selling them in the asset market and this depresses asset prices. As a result, as the banking sector becomes more unstable, consumers hedge against the state of the world in which liquidity is scarce by holding part of their portfolio in liquid funds. Such an outcome is inefficient since a smaller amount is devoted to the long-term (productive) asset.

WORK IN PROGRESS

“Risk Attitude and Monetary Policy: Evidence from Equity Markets,” (with Geert Bekaert, Columbia Business School and Martin Scheicher, ECB). Financial Stability and Monetary Policy