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Working Paper
A Model of Endogenous Debt Maturity with Heterogeneous Beliefs
This paper studies optimal debt maturity in an economy with repayment enforcement frictions and investors disagree about repayment probabilities. The optimal debt maturity choice is a mix of long- and short-term debt securities. Spreading risky debt claims on cash flows over time allows debt to be priced by investors most willing to hold risk at each point in time, thereby increasing investment and output. By contrast, a single maturity, either all long- or short-term, will be priced by investors less willing to hold risk, which reduces investment and output. The model provides a novel ...
Working Paper
Mixed Signals: Investment Distortions with Adverse Selection
We study how adverse selection distorts equilibrium investment allocations in a Walrasian credit market with two-sided heterogeneity. Representative investor and partial equilibrium economies are special cases where investment allocations are distorted above perfect information allocations. By contrast, the general setting features a pecuniary externality that leads to trade and investment allocations below perfect information levels. The degree of heterogeneity between informed agents' type governs the direction of the distortion. Moreover, contracts that complete markets dampen the impact ...
Working Paper
Banks, Non Banks, and Lending Standards
We study how competition between banks and non-banks affects lending standards. Banks have private information about some borrowers and are subject to capital requirements to mitigate risk-taking incentives from deposit insurance. Non-banks are uninformed and market forces determine their capital structure. We show that lending standards monotonically increase in bank capital requirements. Intuitively, higher capital requirements raise banks’ skin in the game and screening out bad projects assures positive expected lending returns. Non-banks enter the market when capital requirements are ...
Working Paper
Credit Default Swaps in General Equilibrium: Spillovers, Credit Spreads, and Endogenous Default
This paper highlights two new effects of credit default swap markets (CDS) in a general equilibrium setting. First, when firms' cash flows are correlated, CDSs impact the cost of capital{credit spreads{and investment for all firms, even those that are not CDS reference entities. Second, when firms internalize the credit spread changes, the incentive to issue safe rather than risky bonds is fundamentally altered. Issuing safe debt requires a transfer of profits from good states to bad states to ensure full repayment. Alternatively, issuing risky bonds maximizes profits in good states at the ...