Search

While the usual paradigm of supply and demand in a frictionless market is useful for dis- cussing many issues, plenty of important questions are not easily addressed with this approach. In this dissertation I aim to further our understanding of markets where trading frictions are relevant from two different perspectives: a search-theoretic model and labora- tory experiments.The first chapter of this dissertation focuses on a frictional labor market where firms can decide to replace current employees by randomly search for new candidates. I show that even in an economy where agents are risk neutral and face no liquidity constraints, severance payments emerge as part of an optimal contract when firms can search on-the-job. An optimal contract is composed of both the wage and a payment conditional on the worker being replaced. The size of the payment is chosen to allow the firm to internalize the externality associated so that firms take into account the total surplus effect of their replacement hire decisions. I add ex ante heterogeneity among workers which makes the pairwise optimal contract insufficient to achieve the constrained-efficient result (even under the Hosios condition) and then use a calibrated version of the model to illustrate that a lower on-the-job search cost can in fact reduce welfare.In the second chapter, I develop an experimental framework to investigate price, output and welfare consequences of implementing the optimal monetary policy in a version of the search- theoretic money model of Lagos and Wright (2005): The Friedman Rule. I aim to further understand previous experimental results by Duffy and Puzzello (2022) which are somewhat at odds with the standard theory and contrary to the optimality of the rule vis-`a-vis an inflationary scheme, which they suggest could be rationalized on the basis of liquidity constraints and/or precautionary motives due to future price uncertainty. For this, I request subjects to make predictions about market prices and include a novel treatment for the decentralized goods market to try and mitigate price uncertainty: prices are exogenously imposed on consumers so they can only select from a fixed menu of quantities (and prices) when making an offer. My results tend to be consistent with previous experimental findings, but no clear evidence for the Friedman Rule emerges. Even when prices are fixed exogenously in pairwise meetings, evidence in favor is still only mixed and high volatility of prices in the centralized market persists. When using subjects own predictions about the centralized market price to look at how they expected to rebalance their holdings conditional on their beliefs there seems to be a clear bias: subjects mostly want to increase their token holdings regardless of previous trades.In the third and last chapter, I use a semi-unstructured bargaining approach to experimentally study the effects of liquidity constraints on the determination of terms of trade. This setting is specially relevant for search-theoretic models of money: trade surplus and its di- vision are endogenously and simultaneously determined, with participants facing possible liquidity constraints due to buyer’s endogenous ex-ante choice of costly money holdings. My aim is to test the empirical relevance of two widely used axiomatic bargaining solutions: generalized Nash bargaining and Kalai’s proportional bargaining. Each bargaining solution predicts different outcomes and buyer’s anticipating their decision’s effect on the bargaining outcome may choose to additionally restrict their money holdings, which can prevent efficient outcomes from being achieved, even when money is costless to hold. A most relevant issue, since the protocol to determine terms of trade in monetary economies is critical for normative results, optimal monetary policy, and the welfare cost of inflation. By imposing different costs to holding money, I find strong evidence that costlier holdings do incentivize participants to economize on money holdings leading to a more constrained bargaining set resulting in less production and surplus, but find only mixed evidence in favor of any of the two bargaining solutions. Finally, I introduce two possible variations to the model that help better understand the data: myopic buyers and a sunk cost fallacy.

This dissertation consists of three essays on the monetary policy pass-through to financial markets and bank balance sheets. I use frontier econometric methods combined with rich micro and macro-level datasets to examine the effect of monetary policy on financial markets and banks' balance sheets, focusing on how specific bank and market characteristics amplifies the monetary policy transmission mechanism. Moreover, I show that monetary policy transmits to real economic outcomes through financial markets and banks' balance sheets. Finally, I complement my empirical findings with theoretical models to identify the underlying monetary policy transmission mechanisms.The first chapter of my dissertation studies the effect of market power on monetary policy transmission to banks' funding dynamics, lending, and profitability by comprehensively studying the interactions among the deposit, wholesale funding, and credit markets, which is missing in the literature. In this chapter, I document the heterogeneous impact of monetary policy on banks' deposit, wholesale funding, and lending spreads depending on the degree of their bank market power. Specifically, I show that after an increase in the policy rate, banks with higher market power increase their deposit and loan rates less and access wholesale funding markets at a relatively lower cost compared to other banks. Hence, banks with higher market power counterbalance the fall in their deposit inflows by increasing their reliance on wholesale funding, and their lending decreases less than other banks following a monetary contraction. This "wholesale funding channel" dampens the adverse effect of contractionary monetary policy on their lending and profitability. I further show that bank market power affects monetary policy transmission to the real economy through its impact on bank-level lending. In particular, aggregate lending and employment decrease less in areas served by banks with higher market power after an increase in the policy rate. Finally, I rationalize my empirical findings by building a theoretical model with monopolistic competition. In the model, banks with higher market power access wholesale funding markets at a lower cost, which generates imperfect pass-through of monetary policy.The second chapter of my dissertation provides a new channel of monetary policy-pass-through to bank lending and lending rates, "bank liquidity channel". In particular, I evaluate monetary policy pass-through conditional on bank liquidity using rich bank-level balance sheets and income statement data. I find that after an increase in the policy rate, funding inflows of banks decreases and constrain banks' loan originations. However, banks with less liquid balance sheets reduce their loan supply more due to their liquidity constraints. In particular, these banks start to shrink their balance sheets by reducing their loan originations as they don't have enough buffer stock liquidity to deplete when they face an adverse shock. Second, I document that banks with less liquid balance sheets increase their loan rates more than other banks following a monetary contraction. Lastly, I build a theoretical model with heterogeneous banks that explains the underlying mechanism. In the model, bank liquidity constraints combined with monopolistic competition impose frictions on monetary policy pass-through to bank lending rates, where there is no deposit rate dispersion among banks based on their liquidity position.Finally, Chapter 3 studies the impact of maturity mismatch between banks' assets and liabilities on monetary policy transmission to bank profitability and asks whether the role of the maturity mismatch channel has changed during the zero lower bound (ZLB) environment. Using high-frequency monetary policy surprises that allow me to separate the effects of conventional and unconventional monetary policy, I first show that bank stock prices decrease significantly after contractionary federal funds rate and forward guidance shocks. That is, the indirect effects of contractionary monetary policy (e.g., the signaling impact of a weaker economy, higher default probabilities, and a weak bank balance sheet performance) outweigh its direct effect (the expected improvement in net interest margins) on banks' stock prices. I then document that banks with larger maturity mismatch are affected less negatively from the contractionary monetary policy surprises as their expected net interest margins rise more after an increase in the level and slope of the yield curve. Turning to the zero lower bound (ZLB) environment, I show that large-scale asset purchases (LSAP) that decrease the long-term yields affect bank stock prices positively during this period. However, the maturity mismatch channel ceased to exist in the ZLB environment. Specifically, the response of bank stock prices stopped varying depending on the maturity structure of their balance sheets, indicating a limitation to unconventional monetary policy.

The dependence of Islamic bank rates on the conventional bank rate violates the religiosity principle and the fundamentals of an efficient market due to the possibility of arbitrage profit from the rate differences. This study tests such dependency in a dual banking system by considering monthly data from January 2009 to April 2018 on Malaysian banks using several ARDL tests, supplemented by robustness tests using a 12-month correlation of the rolling standard deviation and causality models based on the Toda-Yamamoto approach to investigate the short- and long-run dependency of rates. The study finds that Malaysia's Islamic bank deposit and financing rates are influenced by both the conventional and Bank Negara Malaysia's policy rates. Results imply that Islamic banks do serve profit-driven customers. We suggest that Islamic banks are forced to benchmark their rates to conventional rates because of the trade-off between religious and economic fundamentals by profit-driven customers. The study demonstrates that the question of Islamic legitimacy of Islamic banks needs to be addressed considering the correct profiling of the customer-base and the regulatory environment in which Islamic banks operate. We discuss implications for Islamic rate-setting behavior in the presence of monetary shocks in a dual banking system.

Traditionally, equity mispricing has been documented as an important determinant of speed of adjustment to target leverage levels. More recently, the impact of Shari’ah compliance has been shown to significantly affect capital structure decisions. In this paper, we explore the effect of equity mispricing in Shari’ah compliant (vs. non-compliant) firms. We conduct our study on a comprehensive sample of Malaysian firms from year 1998–2016. We show that established findings in the dynamic trade-off theory do not hold for Shari’ah compliant firms. Shari’ah compliant firms increase their reliance on equity financing at greater levels than non-compliant firms when they are above target levels and equities are overpriced. In contrast, for Shari’ah compliant firms below target levels and where equity is under-priced, the rate of adjustment is slower than non-compliant firms. Our findings suggest that managers of Shari’ah compliant firms are inclined to time the equity market when above target levels to capture the impact of lower costs of equity during periods of over-valuation of equity. However, those managers tend to be reluctant to resort to debt financing when below target leverage even in the presence of equity under-pricing.

This paper analyses the effect of bank lending and fee income on Islamic and conventional bank's performance. The paper builds a theoretical model and provides empirical evidence to show that Islamic banks as compared to conventional banks can have a greater reliance on fee-based income than returns from loans to increase their profitability. Using data from a sample of 20 countries for the period from 2000 to 2015 for Islamic and conventional banks, we find that the bank fee is an important determinant of the profitability of an Islamic bank. Interestingly, many commonly used measures such as loan to deposit ratio do not affect the Islamic banks' profitability as much as they do for conventional banks. Our findings imply that Islamic banks' lower sensitivity to loan to deposit ratio may contribute to lower credit risk. However, an over-reliance on fee-based income may affect their growth, profitability and sustainability in the long run.

In this dissertation, I develop a monetary model where money is used in two roles: as the medium of exchange in spot transactions, and as the unit of account in credit contracts. I use this model to jointly study these two functions, comparing their properties and exploring their interactions. In the first chapter, I present the model where money can be used as both medium of exchange and unit of account. These functions stem from limits to trade that can be partially overcome with the use of money. The unit of account role in contracts arises from the need to specify a payment, in terms of goods or money. Here, I establish the conditions for money to be chosen as the unit of account in terms of the stability of both relative prices and the general price level. I also illustrate the benefits of dollarization (writing contracts in a foreign currency) or indexation (allowing contracts to be specified in terms of an artificial unit of account). I then analyze the stationary monetary equilibrium, where the value of money is determined from its demand as medium of exchange and a given monetary policy. As a result of this analysis, I provide several insights into these functions. For instance, the conditions that make money a good medium of exchange are different from the ones that make it a good unit of account. The unit of account role provides a rationale for a price stability goal of monetary policy, distinct from the goal of keeping a low inflation rate. Finally, the model illustrates how a currency can become a better unit of account as a result of being more widely used as a medium of exchange. In the second chapter, I analyze two general approaches to monetary policy: inflation and price-level targeting. The former aims for a target level of inflation, while the latter attempts to keep the level of prices in an established path. In order to compare these two policies, I extend the benchmark model to incorporate long-term contracts. On one hand, price-level targeting enhances the long-term stability of the value of money, making it a better unit of account. On the other hand, inflation targeting is better for the medium of exchange role, since the inflation level is the relevant cost for the use of money in spot transactions. I argue that a combined approach resembles the recent Federal Reserve policy of "flexible average inflation targeting," and that indexation would allow monetary policy to sidestep this trade-off.

We examine how the trade shock from China influences the behavior and investment performance of overconfident CEOs in U.S. firms. We show that the rise of Chinese import competition curbs investments and improves investment value and acquisition performance for firms with overconfident CEOs. Intensified Chinese product competition also reduces the incentives for these firms to expand assets, invest out of cash flows, pursue aggressive financial policies, and increase risk exposure, and enhances their incentives to buy back shares. Overall, the evidence suggests that product market competition is an effective external governance mechanism for curbing the adverse effects of managerial overconfidence.

We examine how firms’ contractual relationships with their employees affect the design of their debt contracts, and the use of financial covenants in particular. Viewing the firm as the nexus of both explicit and implicit contractual relationships, we argue that managers cater to their employees’ preferences when negotiating contractual terms with creditors. We argue that an increase in unemployment-insurance benefits reduces employees’ cost of job loss, which, in turn, allows managers to take more risk. First, we show that more generous benefits are associated with a higher operating leverage, operating cash flow volatility, and product-development frequency. We then find that loans initiated following an increase in unemployment-insurance benefits include a higher proportion of performance, rather than capital covenants. Overall, our study demonstrates how the design of debt contracts changes in response to arguably exogenous changes in employees’ collective tolerance—and, in turn, managers’ preferences—for risk. JEL Classifications: M41; G32; J60.

Forward markets are believed to aggregate information about future spot prices and reduce the cost of producing the commodity. We develop a measure of the extent to which forward and spot prices agree in markets with transaction costs. Using this measure, we show that day-ahead prices better reflect real-time prices at all locations in California’s electricity market after the introduction of financial trading. We then present evidence suggesting that operating costs and input fuel use fell after the introduction of financial trading on days when the nonconvexities inherent to the production and transmission of electricity are especially relevant. (JEL D23, D24, G13, L94, L98, Q48)

Imperfect information and learning are introduced into a production-based asset pricing model. Our model features slow learning about firms’ exposure to aggregate productivity shocks over time. In contrast to a full information case, our framework provides a unified explanation for the stylized empirical features of the cross-section of stocks that differ in capital age: old capital firms (1) have higher capital allocation efficiency; (2) are more exposed to aggregate productivity shocks and, hence, earn higher expected returns, which we refer to as capital age premium; and (3) have shorter cash-flow duration, when compared with young capital firms.

Since 2012, the United States has witnessed explosive growth in mandatory energy efficiency disclosure policies, which aim to address market failures in housing. I examine one such policy, comparing prices before and after the policy’s introduction for homes with different levels of energy efficiency features. I find increased capitalization of energy efficiency features. Effects are larger for difficult-to-observe features, suggesting the results are driven by information and not changing preferences for energy efficiency over time. This highlights the potential for disclosure policies to promote long-run energy efficiency investment by increasing the returns homeowners expect on these investments when they sell.

I document that government debt is related to risk premia in various asset markets: (i) the debt-to-GDP ratio positively predicts excess stock returns with out-of-sample R 2 up to 30% at a five-year horizon, outperforming many popular predictors; (ii) the debt-to-GDP ratio is positively correlated with credit risk premia in both corporate bond excess returns and yield spreads; (iii) higher debt-to-GDP ratio is associated with lower real risk-free rates, (iv) higher debt-to-GDP ratio corresponds to lower average expected returns on government debt; (v) debt-to-GDP ratio positively comoves with fiscal policy uncertainty. I rationalize these empirical findings in a general equilibrium model featuring recursive preferences, endogenous growth, distortionary taxation, and time-varying fiscal uncertainty. In the model, the tax risk premium is sizable and its time variation is driven by fiscal uncertainty. Furthermore, the model generates an endogenous relationship between the debt-to-GDP ratio and fiscal uncertainty. Fiscal uncertainty increases debt valuation through lower government discount rate. This mechanism is reinforced as higher debt conversely raises uncertainty because of future fiscal consolidations.

We study long-run shareholder outcomes for over 64,000 global common stocks during the January 1990 to December 2020 period. We document that the majority, 55.2% of U.S. stocks and 57.4% of non-U.S. stocks, underperform one-month U.S. Treasury bills in terms of compound returns over the full sample. Focusing on aggregate shareholder outcomes, we find that the top-performing 2.4% of firms account for all of the $US 75.7 trillion in net global stock market wealth creation from 1990 to December 2020. Outside the US, 1.41% of firms account for the $US 30.7 trillion in net wealth creation.

We develop a model where persistent trade shocks create demand for a basket- backed stablecoin, such as Mark Carney's "synthetic hegemonic currency" or Facebook's recent proposal for Libra. In numerical simulations, we find four main results. First, because of general equilibrium effects of the basket currency on the volatility of currency values, overall demand for that currency is small. Second, despite scant holdings of the basket, its global reach may contribute to substantial increases in welfare if the basket is widely accepted, allowing it to complement holdings of sovereign currencies. Third, we calculate the welfare maximizing composition of the basket, finding that optimal weights depend on the pattern of international acceptance, but that basket composition does not significantly affect welfare. Fourth, despite potential welfare improvements, low demand for the basket currency from buyers limits sellers' incentives to invest in accepting it, suggesting that fears of a so-called global stablecoin replacing domestic sovereign currencies may be overstated.

When surveys rely on repeat participants, this raises the possibility that survey participation may affect future responses, perhaps by prompting information acquisition between survey waves. We show that these “learning-through-survey” effects are large for household inflation expectations. Repeat survey participants generally have lower inflation expectations and uncertainty, particularly if their initial uncertainty was high. Consequently, repeat participants may be more informed about or attentive to inflation. This has important implications: for example, inflation expectations of new participants are more influenced by oil prices, and estimates of the elasticity of intertemporal substitution are lower for new participants. (JEL C83, D84, E31, E37, E58)

What are the short- and medium-term effects of an import-competition shock on firm dynamics and aggregate productivity? We address this question by combining detailed data on investment dynamics of Peruvian manufacturing firms, data on trade flows from China, and a quantitative general-equilibrium model with heterogeneous firms subject to idiosyncratic shocks. In the data, we find evidence of substantial frictions that slow capital reallocation, by rendering disinvestment and firm exit costly. In our model, these frictions shape the transitional dynamics after a trade shock. On impact, a drop in output prices due to import competition induces a spike in inaction, and exit of some productive firms, consistent with our empirical evidence. These effects expand the aggregate productivity wedge relative to a frictionless benchmark. Overall, productivity gains materialize slowly over time, whereas welfare gains emerge early in the transition.

We empirically investigate how uncertainty endogenously interacts with real activity and monetary policy, and analyze the role of endogeneity in shaping the efficacy of monetary policy using a shock restricted structural vector-auto-regression model. Using the model, we show that both real and financial uncertainty endogenously react to business cycle fluctuations and to monetary policy actions. Then we provide two novel policy implications of endogenous uncertainty. First, a tighter monetary policy reduces financial uncertainty, but heightens real uncertainty. Second, endogeneity channels in uncertainty amplify the real effects of monetary policy.

The purpose of this study is to investigate, by use of relevant robust econometric modelling, physical capital and human capital, and their impact on growth in Indonesia for policy analysis. The Auto Regressive Distributed Lag (ARDL) by Pesaran and Pesaran (1997) were chosen for supporting the relationship analysis. The important finding for policy analysis is that human capital appears to be a continuing factor shaping Indonesia’s growth, along with physical capital accumulation, with particularly strong effects for human capital arising from tertiary education. Physical capital has shown a strong and significant impact on the growth in the long run and indicates that Indonesia needs long term investment to generate growth. Such investment has distinction which related to sustainable operation such as infrastructure, sophisticated services, and venture capital. Consequently, it requires high skill labour supplied by tertiary education institutions. A further development of tertiary education next to enhancement of investment environment in manufacture and service sector should be set as priority programs in inducing growth.

This paper considers an entry game in which an incumbent firm operates in a number of markets and a potential entrant seeks to enter some or all of the markets. While price discrimination has usually been thought of as a barrier to entry, in our model it is not and, on the contrary, we find that charging a uniform price across the markets actually discourages entry. Partial entry occurs when the two firms’ products are highly substitutable. In this case, a ban on price discrimination raises the profits of both the incumbent and the entrant but reduces consumer and total welfare.

We study the influence of bank competition on U.S. public borrowers’ accounting conservatism by exploiting the staggered adoption of the Riegle-Neal Interstate Banking and Branching Efficiency Act (IBBEA) of 1994, which increased the threats of new bank entrants and actual bank entry. We find that borrowers’ conditional conservatism fell after IBBEA. Conservatism fell more for firms located in states with weak incumbent banks and states with more out-of-state entrants, especially entrants with better monitoring technologies. The decrease in conservatism partially stems from borrowers’ increased investment and risk-taking incentives. Conservatism fell more for firms relying more on bank loans, especially those that borrowed loans for the first time after IBBEA and for firms having lower dedicated institutional ownership and board independence. We also find that loans included fewer covenants and that bank loan borrowers became less likely to choose Big N auditors and industry specialist auditors after IBBEA. Data Availability: Data are available from the public sources cited in the text. JEL Classifications: G21; G28; K23; M41.