Person:

Greenwood, Robin

We study optimal government debt maturity in a model where investors derive monetary services from holding riskless short-term securities. In a setting where the government is the only issuer of such riskless paper, it trades off the monetary premium associated with short-term debt against the refinancing risk implied by the need to roll over its debt more often. We then extend the model to allow private financial intermediaries to compete with the government in the provision of short-term, money-like claims. We argue that if there are negative externalities associated with private money creation, the government should tilt its issuance more towards short maturities. The idea is that the government may have a comparative advantage relative to the private sector in bearing refinancing risk and, hence, should aim to partially crowd out the private sector's use of short-term debt.

We present a model in which fire sales propagate shocks across bank balance sheets. When a bank experiences a negative shock to its equity, a natural way to return to target leverage is to sell assets. If potential buyers are limited, then asset sales depress prices, in which case one bank's sales impact other banks with common exposures. We show how this contagion effect adds up across the banking sector, and how it can be estimated empirically using balance sheet data. We compute bank exposures to system-wide deleveraging, as well as the spillovers induced by individual banks. Applying the model to European banks, we evaluate a variety of interventions to reduce their vulnerability to fire sales during the sovereign debt crisis.

We examine empirically how the maturity structure of government debt affects bond yields and excess returns. Our analysis is based on a theoretical model of preferred habitat in which clienteles with strong preferences for specific maturities trade with arbitrageurs. Consistent with the model, we find that (i) the supply of long- relative to short-term bonds is positively related to the term spread, (ii) supply predicts positively long-term bonds' excess returns even after controlling for the term spread and the Cochrane-Piazzesi factor, (iii) the effects of supply are stronger for longer maturities, and (iv) following periods when arbitrageurs have lost money, both supply and the term spread are stronger predictors of excess returns.

We show that the credit quality of corporate debt issuers deteriorates during credit booms, and that this deterioration forecasts low excess returns to corporate bondholders. The key insight is that changes in the pricing of credit risk disproportionately affect the financing costs faced by low quality firms, so the debt issuance of low quality firms is particularly useful for forecasting bond returns. We show that a significant decline in issuer quality is a more reliable signal of credit market overheating than rapid aggregate credit growth. We use these findings to investigate the forces driving time-variation in expected corporate bond returns.

Standard theories of corporate ownership assume that because markets are efficient, insiders ultimately bear all agency costs that they create and therefore have a strong incentive to minimize conflicts of interest with outside investors. We argue that if equity is overvalued, however, mispricing offsets agency costs and can induce a controlling shareholder to list equity. Higher valuations may support listings associated with greater agency costs. We test the predictions that follow from this idea on a sample of publicly listed subsidiaries in Japan. Subsidiaries in which the parent sells a larger stake and subsidiaries with greater scope for expropriation by the parent firm are more overpriced at listing, and minority shareholders fare poorly after listing as mispricing corrects. Parent firms often repurchase subsidiaries at large discounts to valuations at the time of listing and experience positive abnormal returns when repurchases are announced.

We analyze time series of investor expectations of future stock market returns from six data sources between 1963 and 2011. The six measures of expectations are highly positively correlated with each other, as well as with past stock returns and with the level of the stock market. However, investor expectations are strongly negatively correlated with model-based expected returns. The evidence is not consistent with rational expectations representative investor models of returns.

Survey evidence suggests that many investors form beliefs about future stock market returns by extrapolating past returns. Such beliefs are hard to reconcile with existing models of the aggregate stock market. We study a consumption-based asset pricing model in which some investors form beliefs about future price changes in the stock market by extrapolating past price changes, while other investors hold fully rational beliefs. We find that the model captures many features of actual prices and returns; importantly, however, it is also consistent with the survey evidence on investor expectations.

We present an extrapolative model of bubbles. In the model, many investors form their demand for a risky asset by weighing two signals: an average of the asset’s past price changes and the asset’s degree of overvaluation. The two signals are in conflict, and investors “waver” over time in the relative weight they put on them. The model predicts that good news about fundamentals can trigger large price bubbles. We analyze the patterns of cash-flow news that generate the largest bubbles, the reasons why bubbles collapse, and the frequency with which they occur. The model also predicts that bubbles will be accompanied by high trading volume and that volume increases with past asset returns. We present empirical evidence that bears on some of the model’s distinctive predictions.

We study the good- and bad-times performance of equity portfolios formed on characteristics. Many characteristics associated with good performance during bad times – value, profitability, small size, safety, and total volatility – also perform well during good times. Stocks with characteristics signifying high liquidity, such as high turnover and low bid ask spreads, perform well during bad times but otherwise underperform. We develop a simple but flexible procedure to recover a “risk neutral alpha” that recognizes a 1% return experienced during bad times as being more valuable than a 1% return generated during good times. We also show how an investor can build a “rainy day” portfolio that minimizes underperformance during bad times.

The U.S. financial services industry grew from 4.9% of GDP in 1980 to 7.9% of GDP in 2007. A sizeable portion of the growth can be explained by rising asset management fees, which in turn were driven by increases in the valuation of tradable assets, particularly equity. Another important factor was growth in fees associated with an expansion in household credit, particularly for residential mortgages. This expansion was itself fueled by the development of non-bank credit intermediation (or "shadow banking"). Whether the growth of the financial sector has been socially beneficial depends on one's view of active asset management, the increase in household credit, and the growth of shadow banking. While recognizing some of the benefits of professional asset management, we are skeptical about the marginal value of active asset management. We then raise concerns about whether the potential benefits of increased access to household credit—the main output of the shadow banking system—are outweighed by the risks inherent in this new approach to credit delivery.