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We investigate the effects of a sustained increase in liquidity (a savings glut) on the incentives to originate high quality assets and on the fragility of the financial sector. Originators incur private costs when originating high quality assets. Assets are subsequently distributed in two markets by the financial sector: A private market where informed intermediaries operate and an exchange where uninformed liquidity trades. Uninformed liquidity pays the same price irrespective of the quality of the assets, which discourages good origination. Informed liquidity instead creams skims the best assets paying a premium over the uninformed price, which encourages originators to supply good assets. We show that the positive origination effects of an increase in liquidity matter when the overall level of liquidity is low whereas the opposite is true when liquidity is abundant. Thus an increase in the overall level of liquidity has a non-monotone effect on the incentives to originate high quality assets. Instead leverage increases monotonically with liquidity and is highest precisely when incentives for good asset origination are at their lowest. As a result plentiful liquidity leads to fragile balance sheets: On the asset side there are more low quality assets and on the liability side more of those assets are funded with debt. We relate our findings to some of the stylized facts observed in financial markets in the lead up to the Great Recession and draw policy conclusions from the model.

Nirei and Scheinkman (2021) proposed an equilibrium model of price adjustments with menu-costs with a finite number of firms and derived a “reproduction number” for repricing and a limit functional form for the distribution of the number of simultaneously price-adjusting firms. We show that the distribution of price-changes in data from the Billion Prices Project is well fitted by this functional form and exhibits a reproduction number that is close to unity, indicating that complementarity in price-changes plays a major role in repricings.

In this Supplementary Appendix, we extend the baseline model of "Repricing Avalanches" to the case where productivity is not constant. Even though some portions are straightforward extension of the baseline model, we allow for some overlap with the main text for the sake of a self-contained exposition of the extended model.

We study asset and debt characteristics of US bank holding companies. We show that financial institutions, especially large institutions, are not just about holding discrete assets. Services and going-concern values are important, and capital market debt against going-concern values accounts for 10% to 15% of total assets, comparable to the volume of capital market debt against discrete assets. We find that financial institutions’ debt against going-concern values has weak monitoring, relative to similar debt among non-financial firms. We argue that weak monitoring prevails because creditors cannot easily punish or restructure these institutions should they violate covenants, which limits covenants’ usefulness.

We study the speculative value of a finitely lived asset when investors disagree and short sales are limited. In this case, investors are willing to pay a speculative value for the resale option they obtain when they acquire the asset. Using martingale arguments, we characterize the equilibrium speculative value as a solution to a fixed point problem for a monotone operator $$\mathbb F$$ . A Dynamic Programming Principle applies and is used to show that the minimal solution to the fixed-point problem is a viscosity solution of a naturally associated (non-local) obstacle problem. Combining the monotonicity of the operator $${\mathbb {F}}$$ and a comparison principle for viscosity solutions to the obstacle problem we obtain several comparison of solution results. We also use a characterization of the exercise boundary of the obstacle problem to study the effect of an increase in the costs of transactions on the value of the bubble and on the volume of trade, and in particular to quantify the effect of a small transaction (Tobin) tax.

The death of an artist constitutes a negative supply shock to his future produc- tion; in finance terms, this supply shock reduces the artist’s float. Intuition may thus suggest that this supply shock reduces the future auction volume of the artist. However, if collectors have fluctuating heterogeneous beliefs, since they cannot sell short, prices overweigh optimists’ beliefs and have a speculative component. If collectors have limited capacity to bear risk, an increase in float may decrease sub- sequent turnover and prices (Hong et al., 2006). Symmetrically, a negative supply shock leads to an augmentation of prices and turnover. We find strong support for this prediction in the data on art auctions that we examine.

We present a state-dependent pricing model that generates inflation fluctuations from idiosyncratic shocks to the cost of price changes of individual firms. A firm's nominal price increase, lowers other firms' relative prices, thereby inducing further nominal price increases. This snow-ball effect of repricing causes fluctuations to the aggregate price level without exogenous aggregate shocks. The fluctuations caused by this mechanism are more volatile when the density of firms at the repricing threshold is high, and the density at the threshold is high when the trend inflation level is high. Thus, the model implies that higher trend inflation produces larger volatility of short-term inflation rates. Analytical and numerical analyses show that the model can account for the positive relationship between inflation level and volatility that has been observed empirically.

The death of an artist constitutes a negative supply shock to his future produc- tion; in finance terms, this supply shock reduces the artist’s float. Intuition may thus suggest that this supply shock reduces the future auction volume of the artist. However, if collectors have fluctuating heterogeneous beliefs, since they cannot sell short, prices overweigh optimists’ beliefs and have a speculative component. If collectors have limited capacity to bear risk, an increase in float may decrease sub- sequent turnover and prices (Hong et al., 2006). Symmetrically, a negative supply shock leads to an augmentation of prices and turnover. We find strong support for this prediction in the data on art auctions that we examine.

In this chapter, the authors describe the bulk of their argument: in the presence of externalities generated by learning-by-doing mechanism and with differential products, free trade and competitive behavior tend to magnify small differences in the initial conditions. The remark that externalities may affect the dynamic evolution of comparative advantages was made by Krugman and Lucas. The research effort that underlies the simple model was motivated by a few undisputable facts. The authors present a general formalized version of the world economy and describe the dynamic process for expertise and the associated competitive growth path. They also present a simple linear model where such a dynamic is realized, albeit in a very extreme form. The authors provide an analysis of the conditions under which the general model produces the asymmetric outcomes people have in mind.

The general topics for discussion and questions addressed to this group were the following: Economic development as a complex system, as a pattern problem. Are there many equivalent states? Can one model the diffusion of development as a reaction-diffusion front? Political input as damping/enhancing factor in development. Regional economic differences. Is there a tendency to polarization? Do reaction models offer a parallel? Is this paralleled by international economic differences? Review of possibilities for lock-in. Do such methods as annealing suggest policies or spontaneous actions of the economic system for removing harmful lock-in?

Recently, J. Scheinkman and B. Le Baron have analyzed a time series of weekly stock returns from the point of view of nonlinear dynamics. In particular, using the Grassberger-Procaccia algorithm, they found the data to be compatible with a deterministic dynamical system of low dimension perturbed by a moderate amount of noise. This chapter analyses the same time series, and obtain an estimate of Lyapunov exponents, that is, rates of exponential growth of small perturbations to initial conditions. It also analyzes the data for temporal homogeneity by producing a recurrence plot to obtain this plot the weekly returns time series is first used to generate a six-dimensional trajectory by the time-delay method. The recurrence plot, apart form a short exceptional period near the beginning of the time series, appears reasonably uniform. This seems to indicate that there is not much drift–in the more than twenty years studied–for the behavior of weekly returns over a few weeks.

Many believe that compensation, misaligned from shareholders’ value due to managerial entrenchment, caused financial firms to take risks before the financial crisis of 2008. We argue that, even in a classical principal-agent setting without entrenchment and with exogenous firm risk, riskier firms may offer higher total pay as compensation for the extra risk in equity stakes borne by risk-averse managers. Using long lags of stock price risk to capture exogenous firm risk, we confirm our conjecture and show that riskier firms are also more productive and more likely to be held by institutional investors, who are most able to influence compensation.

We propose a continuous-time model of trading among risk-neutral agents with heterogeneous beliefs. Agents face quadratic costs-of-carry on their positions and as a consequence, their marginal valuation of the asset decreases when the magnitude of their position increases, as it would be the case for risk-averse agents. In the equilibrium models of investors with heterogeneous beliefs that followed the original work by Harrison and Kreps, investors are risk-neutral, short-selling is prohibited and agents face a constant marginal cost of carrying positions. The resulting resale option guarantees that the equilibrium price exceeds the price of the asset in a static buy-and-hold model where speculation is ruled out. Our model features three main novelties. First, increasing marginal costs entail that the price depends on the exogenous supply. Second, in addition to the resale option, agents may also value an option to delay, and this may cause the market to equilibrate \emph{below} the static buy-and-hold price. Third, we introduce the possibility of short-selling; then the resale option for agents with short positions partly compensates the resale option for long agents. We characterize the unique equilibrium of our model through a Hamilton-Jacobi-Bellman equation of a novel form and use it to derive several comparative statics results.

We construct shock elasticities that are pricing counterparts to impulse response functions. Recall that impulse response functions measure the importance of next-period shocks for future values of a time series. Shock elasticities measure the contributions to the price and to the expected future cash flow from changes in the exposure to a shock in the next period. They are elasticities because their measurements compute proportionate changes. We show a particularly close link between these objects in environments with Brownian information structures.

We test implications of a simple equilibrium model of informality using a survey of 48,000+ small firms in Brazil. In the model, agents' ability to manage production differs and informal firms face a higher cost of capital and limitation on size, although these informal firms avoid tax payments. As a result, informal firms are managed by less able entrepreneurs, are smaller, and employ a lower capital–labor ratio. The model predicts that the interaction of an index of observable inputs to entrepreneurial ability and formality is positively correlated with firm size, which we verify in the data. Using the model, we estimate that informal firms in our dataset faced at least 1.3 times the cost of capital of formal firms.

We present an equilibrium model of tax avoidance and test its implications using a survey of firms in Brazil. In the model, the credit method used to collect value-added tax (VAT) creates informality chains—clients or suppliers of informal firms are more likely to be informal. An increase in enforcement in a production stage increases formality downstream and upstream. Various empirical measures of formality of suppliers and buyers, and of enforcement downstream and upstream, are positively correlated with formality. When the VAT is applied in a single stage of production at a rate estimated by the authorities, these chain effects disappear. (JEL H25, H26, L14, L21, O14, O17)

As the record of Federal Reserve interventions over the past year, from December 2007 to December 2008, makes abundantly clear, a foremost concern of monetary authorities in responding to the financial crisis has been to avoid a repeat of the Great Depression, and especially a repeat of the monetary contraction that Milton Friedman and Anna Schwartz (1963) have claimed as the major cause of the 1930s Depression. The Fed has shown tremendous resourcefulness and inventiveness in its liquidity injections, considerably widening the collateral eligible under the discount window and the term auction facility, and setting up new programs targeted at primary dealers, the commercial paper market, and money market funds. At the same time it has stepped in to offer guarantees on assets held by some financial institutions (e.g., Citigroup) to avoid their bankruptcy (see David Enrich et al. 2008). This unprecedented intervention has had the intended effect of averting a major systemic financial meltdown and it has kept some critical financial institutions afloat. Yet, until now, banks have mostly responded by cutting new lending and hoarding liquidity, so that the ultimate goal of forestalling a credit crunch has not been achieved. For the most part, banks also are still holding most of the toxic assets that Monetary Policy, liquidity, and Financial crises †

We investigate the effects of an increase in liquidity (a "savings glut" ) on the incentives to originate high quality assets, and on the fragility of the financial sector. Originators incur private costs when originating high quality assets. Assets are subsequently distributed in two markets: A private market where informed intermediaries operate, and an exchange where uninformed investors trade. Uninformed investors pay the same price irrespective of the quality of the assets, which discourages good origination. Informed investors identify and pick the best assets by offering a premium over the uninformed price, which encourages originators to supply good assets. We show that there is a positive origination effect of an increase in savings of uninformed investors when the overall level of savings is low, but the opposite is true when liquidity is abundant, so that an increase in savings has a non-monotone effect on origination incentives. Leverage increases monotonically with savings and is highest precisely when incentives for good asset origination are at their lowest. Thus plentiful liquidity leads to fragile balance sheets: On the asset side non-performing assets accumulate and on the liability side more of those assets are funded with debt. We relate our findings to some of the stylized facts observed in financial markets in the lead up to the Great Recession.

Valuing executive stock options is a challenging problem, because the standard risk-neutral valuation of those options is not appropriate; the executive is not allowed to trade the stock of the firm, so is not operating in a complete market. As this paper shows, an executive holding many American-style call options on his firm’s stock will optimally exercise the options bit by bit, whereas a risk-neutral valuation of the options would assume that all are exercised at the same time. Comparative statics of the optimal exercise policy show many surprising features.

The short ratio - shares shorted to shares outstanding - is an oft-used measure of arbitrageurs’ opinion about a stock’s over-valuation. We show that days-to-cover (DTC), which divides a stock’s short ratio by its average daily share turnover, is a more theoretically well-motivated measure because trading costs vary across stocks. Since turnover falls with trading costs, DTC is approximately the marginal cost of the shorts. At the arbitrageurs’ optimum it equals the marginal benefit, which is their opinion about over-valuation. DTC is a better predictor of poor stock returns than short ratio. A long-short strategy using DTC generates a 1.2% monthly return.

In this paper, we establish existence and uniqueness results for equilibria in systems with an infinite number of agents and with local and global social interactions. We also examine the structure of the equilibrium distribution and derive a “Markov”property for the equilibrium distribution of a class of spatially homogeneous systems.

We present a multiperiod agency model of stock-based executive compensation in a speculative stock market, where investors have heterogeneous beliefs and stock prices may deviate from underlying fundamentals and include a speculative option component. This component arises from the option to sell the stock in the future to potentially overoptimistic investors. We show that optimal compensation contracts may emphasize short-term stock performance, at the expense of long-run fundamental value, as an incentive to induce managers to pursue actions which increase the speculative component in the stock price. Our model provides a different perspective on the recent corporate crisis than the “rent extraction view” of executive compensation. Copyright 2006, Wiley-Blackwell.

Motivated by the behavior of asset prices, trading volume, and price volatility during episodes of asset price bubbles, we present a continuous‐time equilibrium model in which overconfidence generates disagreements among agents regarding asset fundamentals. With short‐sale constraints, an asset buyer acquires an option to sell the asset to other agents when those agents have more optimistic beliefs. As in a paper by Harrison and Kreps, agents pay prices that exceed their own valuation of future dividends because they believe that in the future they will find a buyer willing to pay even more. This causes a significant bubble component in asset prices even when small differences of beliefs are sufficient to generate a trade. In equilibrium, bubbles are accompanied by large trading volume and high price volatility. Our analysis shows that while Tobin’s tax can substantially reduce speculative trading when transaction costs are small, it has only a limited impact on the size of the bubble or on price volatility.

In many countries, the operation of legal, political and regulatory institutions is subverted by the wealthy and the politically powerful for their own benefit. This subversion takes the form of corruption, intimidation, and other forms of influence. We present a model of such institutional subversion – focusing specifically on courts – and of the effects of inequality in economic and political resources on the magnitude of subversion. We then use the model to analyze the consequences of institutional subversion for the law and order environment in the country, as well as for capital accumulation and growth. We illustrate the model with historical evidence from Gilded Age United States and the transition economies of the 1990s. We also present some cross-country evidence consistent with the basic prediction of the model.

We study the speculative value of a finitely lived asset when investors disagree and short sales are limited. In this case, investors are willing to pay a speculative value for the resale option they obtain when they acquire the asset. Using martingale arguments, we characterize the equilibrium speculative value as a solution to a fixed point problem for a monotone operator F. A Dynamic Programming Principle applies and is used to show that the minimal solution to the fixed-point problem is a viscosity solution of a naturally associated (non-local) obstacle problem. This obstacle type free boundary problem was the focus of Berestycki et al. (2014), who proved a comparison principle and existence and uniqueness of the viscosity solution. Combining the monotonicity of the operator F and the comparison principle we obtain several comparison of solution results. We also use the characterization of the exercise boundary of the obstacle problem to study the effect of an increase in the costs of transactions on the value of the bubble and on the volume of trade, and in particular to quantify the effect of a small transaction (Tobin) tax.

A crowded trade emerges when speculators' positions are large relative to the asset's liquidity, making exit difficult. We study this problem of recent regulatory concern by focusing on short-selling. We show that days to cover (DTC), the ratio of short interest to trading volume, measures the costliness of exiting crowded trades. Crowding is an important concern as short-sellers avoid illiquid stocks, which we establish using an instrumental-variables strategy involving staggered stock market decimalization reforms. Arbitrageurs require a premium to enter into such trades as a strategy shorting high DTC stocks and buying low DTC stocks generates a 1.2% monthly return. A smaller days-to-cover effect also exists on the long positions of levered hedge funds.

We consider an evolution non-local free boundary problem that arises in the modelling of speculative bubbles. The solution of the model is the speculative component in the price of an asset. In the framework of viscosity solutions, we show the existence and uniqueness of the solution. We also show that the solution is convex in space, and establish several monotonicity properties of the solution and of the free boundary with respect to parameters of the problem. To study the free boundary, we use, in particular, the fact that the odd part of the solution solves a more standard obstacle problem. We show that the free boundary is and describe the asymptotics of the free boundary as c , the cost of transacting the asset, goes to zero.

We construct shock elasticities that are pricing counterparts to impulse response functions. Recall that impulse response functions measure the importance of next-period shocks for future values of a time series. Shock elasticities measure the contributions to the price and to the expected future cash flow from changes in the exposure to a shock in the next period. They are elasticities because their measurements compute proportionate changes. We show a particularly close link between these objects in environments with Brownian information structures.

Futures exchanges and other financial intermediaries assume counterparty risks and, in return, demand guarantees that these counterparties will deliver on their promises. It is often argued that, to attract volume, financial intermediaries would settle for excessively low contractual guarantees. In Santos and Scheinkman (2001), we model financial intermediation in an environment where traders may choose to default, and we examine the characteristics of the equilibrium. In particular, we investigate whether competition implies excessively low standards. We show that, in fact, when society punishes default and intermediaries can impose collateral requirements effectively to limit the size of positions, competition leads to a (constrained) optimal amount of contractual guarantees. In Santos and Scheinkman (2001) we assume that exchanges cannot control the size of the positions taken by individuals, but we preclude investors from participating in more than one exchange. This ignores the effect that trading with one financial intermediary may have on the risks faced by other intermediaries. Financial intermediaries typically cannot control the amount of risk that counterparties will take with other intermediaries. In this paper we examine the effect of dropping the exclusivity assumption. We show that the constrained optimum can no longer be implemented as a standard Nash equilibrium with free entry. Nonetheless this allocation is the only one that can be sustained as an anticipatory equilibrium (Charles Wilson, 1977). To break a candidate anticipatory equilibrium it must be possible to add a contract that is profitable and that does not become unprofitable when the now unprofitable contracts from the original menu are withdrawn. If one views this requirement as reasonable, nonexclusivity reproduces the outcome that obtains when intermediaries enjoy exclusivity but cannot control the size of positions taken against them by traders. A superficially similar result holds in the insurance model of Richard Arnott and Joseph E. Stiglitz (1993). In that model, the price of insurance is simply the ratio of what the client pays in the favorable state versus what he receives in the adverse state. As a consequence, if insurers cannot control the size of policies, it makes no difference whether a client buys from one or many insurance companies: clients will buy as much as desired at the lowest price. As we will show below, in our model of financial intermediation, agents may want to combine several contracts, and this is precisely the reason why the original equilibrium does not survive as a Nash equilibrium once exclusivity is dropped.

We consider an environment of a fixed size that can be converted to another use. This conversion can be made in steps, but it is irreversible. The future benefits (per unit) from the original use, and from the alternative use, follow a diffusion process. For a fairly general case, we show that the value function must be the unique (viscosity) solution to the associated Hamilton-Jacobi-Bellman equation. We also exhibit several properties of the solution for the case of constant relative risk aversion between 0 and 1, and a log-linear diffusion for the benefits. Journal of Economic Literature Classification Numbers: C61, D90, Q30.

This paper shows how to identify nonparametrically scalar stationary diffusions from discrete-time data. The local evolution of the diffusion is characterized by a drift and diffusion coefficient along with the specification of boundary behavior. We recover this local evolution from two objects that can be inferred directly from discrete-time data: the stationary density and a conveniently chosen eigenvalue–eigenfunction pair of the conditional expectation operator over a unit interval of time. This construction also lends itself to a spectral characterization of the over-identifying restrictions implied by a scalar diffusion model of a discrete-time Markov process.

We construct shock elasticities that are pricing counterparts to impulse response functions. Recall that impulse response functions measure the importance of next-period shocks for future values of a time series. Shock elasticities measure the contributions to the price and to the expected future cash flow from changes in the exposure to a shock in the next period. They are elasticities because their measurements compute proportionate changes. We show a particularly close link between these objects in environments with Brownian information structures.

We present a model of market-making in which traders possess private and heterogeneous information, and the market-maker acts strategically to maximize profits. Thus, the market-maker must now consider that the prices he sets affect both the information he acquires (through the order flow) and the amount of aggregated information he releases back to the market. We show that the equilibrium price as a function of the order flow displays a discontinuity. This discontinuity can be interpreted as a price crash, since an arbitrarily small change in underlying market variables can lead to a large change in price. At this point, there is also a discontinuity in the information content of price. Journal of Economic Literature Classification Numbers: D82, D84, G14, G20.

In this article we cbaracterize and estimate the process for short-term interest rates using federal funds interest rate data. We presume that we are observing a discrete-time sample of a stationary scalar diffusion. We concentrate on a class of models in whicb the local volatility elasticity is constant and the drift has aflexible specUfication. To accommodate missing observations and to break the link between "economic time" and calendar time, we model the sampling scheme as an increasing process that is not directly observed. We propose and implement two new methods for estimation. We find evidence for a volatility elasticity between one and onehalf and two. When interest rates are high, local mean reversion is smaUl and the mechanism for inducing stationarity is the increased volatility of the diffusion process.

This essay models the sequencing of privatization within an industry and across industries. When a primary advantage of private over public ownership is more responsiveness to information about consumer demand and input costs, then privatization should begin where uncertainty or ignorance is greatest and in areas that transmit information to other agents. Privatizing middlemen has particular value when neighboring sectors are also private. If the retail sector is private, then privatization downstream usually dominates privatization upstream. Industries facing elastic demand should be privatized first when there is uncertainty about costs.

This paper presents a test of independence that can be applied to the estimated residuals of any time series model that can be transformed into a model driven by independent and identically distributed errors. The first order asymptotic distribution of the test statistic is independent of estimation error provided that the parameters of the model under test can be estimated -consistently. Because of this, our method can be used as a model selection tool and as a specification test. Widely used software1 written by Dechert and LeBaron can be used to implement the test. Also, this software is fast enough that the null distribution of our test statistic can be estimated with bootstrap methods. Our method can be viewed as a nonlinear analog of the Box-Pierce Q statistic used in ARIMA analysis.

In this paper, we consider an evolution non local free boundary problem that arises in the modeling of speculative bubbles. The solution of the model is the speculative component in the price of an asset. In the framework of viscosity solutions, we show the existence and uniqueness of the solution. We also show the convexity in space of the solution, and various monotonicity properties of the solution and of the free boundary with respect to parameters of the problem.In order to study the free boundary, we use in particular the fact that the odd part of the solution solves a more standard obstacle problem. We show moreover that the free boundary is Lipschitz continuous, and describe the asymptotics of the free boundary as c, the cost of transacting the asset, goes to zero.

We examine the relationship between urban characteristics in 1960 and urban growth between 1960 and 1990. Income and population growth move together, and both types of growth are (1) positively related to initial schooling, (2) negatively related to initial unemployment, and (3) negatively related to the initial share of employment in manufacturing. Racial composition and segregation are uncorrelated with urban growth across all cities, but in cities with large nonwhite communities segregation is positively correlated with population growth. Government expenditures (except for sanitation) are uncorrelated with growth; government debt is positively correlated with later growth.

Continuous-time Markov processes can be characterized conveniently by their infinitesimal generators. For such processes there exist forward and reverse-time generators. The authors show how to use these generators to construct moment conditions implied by stationary Markov processes. Generalized method of moments estimators and tests can be constructed using these moment conditions. The resulting econometric methods are designed to be applied to discrete-time data obtained by sampling continuous-time Markov processes. Copyright 1995 by The Econometric Society.

An inuential thesis, dubbed \Doing Well by Doing Good", argues that corporate social responsibility is protable. We establish that, if anything, the reverse is true: rms do good only when they do well in the sense of having nancial slack. We model a rm’s optimal choices of capital and goodness subject to nancial constraints. Lessconstrained rms spend more on goodness. We verify that in the data less constrained rms indeed have higher goodness scores and establish causality by using a quasiexperiment. During the Internet bubble, previously constrained rms experienced a temporary relaxation of their constraints and their goodness also temporarily increased relative to their previously unconstrained peers. Goodness is also more sensitive to nancial constraints than capital or R&D spending.

Recursive utility models of the type introduced by Kreps and Porteus (1978) are used extensively in applied research in macroeconomics and asset pricing in environments with uncertainty. These models represent preferences as the solution to a nonlinear forward-looking difference equation with a terminal condition. Such preferences feature investor concerns about the intertemporal composition of risk. In this paper we study infinite horizon specifications of this difference equation in the context of a Markov environment. We establish a connection between the solution to this equation and to an arguably simpler Perron-Frobenius eigenvalue equation of the type that occurs in the study of large deviations for Markov processes. By exploiting this connection, we establish existence and uniqueness results. Moreover, we explore a substantive link between large deviation bounds for tail events for stochastic consumption growth and preferences induced by recursive utility.

An influential thesis, dubbed "Doing well by doing good," argues that corporate social responsibility is profitable. But heterogeneity in firm financial constraints can induce a spurious correlation between profits and goodness even if the motives for goodness are non-profit in nature. We use two identification strategies to show that financial constraints are indeed an important driver of corporate goodness. First, during the Internet bubble, previously constrained firms experienced a temporary relaxation of their constraints and their goodness temporarily increased relative to their previously unconstrained peers. Second, a constrained firm's sustainability score increases more with its idiosyncratic equity valuation and lower cost of capital than a less-constrained counterpart. In sum, firms are more likely to do good when they do well.