Working Papers

Capital Controls and Misallocation (with Hernan Seoane and Lian Allub).

We study the effects of international flow volatility on the productivity of an economy and the desirability of a capital control. Productivity is endogenous, and depends on the allocations of resources. Entrepreneurs can decide either to do a small project  (akin to services) or a big project (akin to manufacturing). Due to financial frictions they require some funding that they obtain via the international investors. International investors are of two types: short-term and long-term.  Long-term investors are subject to a shock to its opportunity cost -- a sudden stop. Thus, there is expected volatility in the interest rate. This makes entrepreneurs decide on smaller or less productive projects, as to avoid the risk. Thus, an aggregate shock to the interest rate interacts with the financial friction to generate misallocation.  A capital control has two effects. On the one one hand, it decreases the amount of liquidity of the economy. On the other hand, reduces the volatility of the interest rate. This increases productivity and thus increases the supply of funds from long term investors, thus partially offsetting the liquidity effect. The model is consistent with several facts regarding sudden stops.  We explore the quantitative effects in a model of occupational choice with two sectors, and financial frictions as in Buera, Kaboski and Shin (2011), where we include international investors and aggregate uncertainty..

Banks vs Zombies, submitted.

 

During times of financial crisis, banks may keep credit flowing to cover the losses of insolvent borrowers or ``zombie firms.'' This practice, known as evergreening or zombie-lending, has occurred even when debt restructuring is allowed. I study the incentives to restructure debt in a borrower-lender game with risk shifting under debt overhang. I provide conditions under which it is optimal to engage in zombie-lending even when socially inefficient. In normal times, the borrower can access a competitive credit market and pay the opportunity cost of capital. When a shock renders the creditor insolvent, debt needs to be restructured. The firm is locked-in and the incumbent bank has monopoly power. A lender can either  liquidate the firm, fund investment or keep the firm in zero profits. Liquidation is not desirable given that disruption costs destroy value. Extending fresh funds requires a large  repayment which incentivizes firms to take more risk, thus decreasing the overall value for the bank. Thus, the bank prefers to keep the firm afloat. When the lender is also financially distressed, the bank may keep the firm afloat to prevent risking its own bankruptcy. Zombie-lending can happen for profitable investments and renegotiation does not solve the problem. I discuss policy alternatives and show that monetary policy and bank capitalizations can be ineffective and that debt haircuts are necessary. 

Certainty and Decisions in Experimental Asset Markets [Website]   (with Rasmus Pank Roulund), revise and resubmit at the Journal of Economic Behavior and Organization.

 

This paper examines how traders' certainty and market certainty affect outcomes in an experimental asset market with known fundamental values. In this type of market, prices usually present large deviations from the fundamental value; in other words, bubbles are known to occur. We measure beliefs by asking participants to forecast the one-period-ahead price as a discrete probability mass distribution. We define certainty as the inverse of the dispersion of beliefs for each trader, and also create a market-wide measure of this to measure agreement across traders. We find that certainty affects price-formation and is also important in explaining the dynamics and size of the bubble. Moreover, as traders are successful they become increasingly more certain in their beliefs, even if these are on non-fundamental values, thus increasing the likelihood of price bubbles.

Forecast.js: A Module for Measuring Expectations in Experiments. [Website] (with Rasmus Pank Roulund), submitted.

This paper presents a elicitation tool for economic experiments based on Harrison et al, 2017. The tool is user-friendly and enables subjects to forecast the movements of a continuous or discrete variable while addressing the main problems in eliciting beliefs. The module is easy to integrate with HTML-based experimental software kits, such as oTree (Chen et al., 2016)

 

Work In Progress (drafts available upon request)

Optimal Haircuts  (with Francisco Roldan)

This paper studies the desirability of private debt haircuts in a simple model of heterogeneous firms and households. Households finance firm's working capital, and firms are credit constrained and differ in their debt levels. When there is an aggregate shock, less productive firms go bankrupt. This directly decreases the demand for labor and the wage receipts for households and indirectly decreases income from the defaulted loans to firms. The main result of the paper is that there is an optimal haircut for deposits such that both firms and families are better off. Moreover, there is a tension between maximizing welfare and maximizing output. This provides a rationale for the Cyprus, Greek and Argentinean experience.  The quantitative exercise uses a model of heterogeneous firms and and matches the Argentinean devaluation episode of 2001 to an aggregate shock.

Behavioral Cycles  (with Pablo Forero)

 

We include behavioral biases in an open economy real business cycle model. Agents learn about different mental models regarding the processes generating disposable income. We combine Barberis et al (1998) and Mullainathan (2002) in order to create waves of optimism, pessimism, overreaction and underreaction. The model can explain three stylized facts found in developing economies that the standard model cannot capture: i) high consumption to output volatility ii) countercyclical trade balance and iii) sudden stops. Policy implications are discussed.

Presented at the Annual Meeting of the Argentinean Economic Association and Trento Summer School on Macroeconomic Crisis.

Sudden Stops and Where to Find Them (with Francisco Roldan and Hernan Seoane)

The trade channel of contagion  (with Alvaro  Perez and Hernan Seoane)

Zombie firms and interbank linkeages: Evidence from spain (new draft coming soon)

A-Tree: A new o-Tree platform to run asset market experiments. (with Rasmus Pank Roulund)