Working Papers

Intermediation in the Interbank Lending Market (R&R, Journal of Financial Economics) 

joint with Ben Craig (Cleveland Fed)

This paper studies systemic risk in the interbank market. We first establish that in the German interbank lending market, a few large banks intermediate funding flows between many smaller periphery banks. Shocks to these intermediary banks in the financial crisis spill over to the activities of the periphery banks. We then develop a network formation model in which banks trade off the costs and benefits of link formation to explain these patterns. The model is structurally estimated using banks’ preferences as revealed by the observed network structure in the pre-crisis period. It explains why the interbank intermediation arrangement arises, estimates the frictions underlying the arrangement, and quantifies how shocks are transmitted across the network. Model estimates based on pre-crisis data successfully predict changes in network-links and in lending arising from the crisis-shocks to the intermediary banks. The model is used to quantify the systemic risk of a single intermediary and the impact of ECB funding in reducing this risk.

Passthrough of Treasury Supply to Bank Deposits

joint with Wenhao Li (USC Marshall) and Yang Zhao (Stanford GSB)


We demonstrate the impact of treasury supply on commercial banks' funding. We show that banks widen their deposit spread as treasury supply increases, leading to a net deposit outflow. At the same time, wholesale funding ratios increase. Both effects are heterogeneous in nature — banks in more competitive markets experience larger outflows and more pronounced jumps in wholesale funding. Results remain robust after controlling for investment opportunities and fed funds rate changes. The empirical findings are rationalized with a search model, in which banks' market power stems from the presence of inattentive depositors. Consistent with Drechsler, Savov and Schnabl (2017), the model predicts the opposite effect for Fed Funds rate hikes, i.e., a larger response in less competitive markets. Our model also sheds light on the effects of the Reverse Repo Facility.

Debt and Equity in Liquidity Provision

joint with Kairong Xiao (Columbia GSB) and Yao Zeng (U. Washington)

We propose a unified framework to study liquidity provision by debt-issuing versus equity-issuing financial intermediaries. We show that both types of intermediaries provide liquidity in the sense of insuring against idiosyncratic liquidity risks as in Diamond and Dybvig (1983). However, each contractual form brings about a distinct friction: the fixed value of debt induces panic runs whereas the flexible payoff of equity renders investor redemptions more sensitive to news on fundamentals, i.e., a flow-to-fundamentals relationship. Both frictions constrain liquidity provision by generating inefficient premature liquidation of long-term investments. Ex-ante, debt provides more (less) liquidity than equity when the fundamentals are relatively better (worse). Informed by the theory, we develop the Liquidity Provision Index (LPI) as a measure of liquidity provision for debt- and equity issuing intermediaries. We find that, at the end of 2017, liquidity provision by a dollar of bond mutual fund shares amounts to a quarter of that by a dollar of uninsured bank deposits; the gap has been narrowing over time partially as a consequence of Quantitative Easing and the Liquidity Coverage Ratio. The bulk of this gap arises from the difference in contract forms but not from indirect effects of other regulatory features such as deposit insurance. Applying the LPI to money market funds (MMFs), we identify a 20% drop in liquidity provision due to the change from debt to equity funding around the 2016 MMF Reform.

Work in Progress

The Safe Asset Equilibrium

joint with William Diamond (Wharton) and Zhengyang Jiang (Kellogg)

Competition in Liquidity Provision by Banks and Non-banks

joint with Kairong Xiao (Columbia GSB) and Yao Zeng (U. Washington)

Monetary Policy Transmission in Segmented Markets

joint with Jens Eisenschmidt (ECB) and Anthony Zhang (Chicago Booth)

Financial Stability and the Overnight RRP Facility

joint with Gabriele La Spada (New York Fed)

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