We document that positive association between corporate and sovereign cost of funds borrowed on global capital markets weakens during periods of unusually high sovereign yields, when corporate borrowers are able to issue debt that is priced at lower rates than sovereign debt. This state-dependent sensitivity of corporate yields to sovereign yields has not been previously documented in the literature. We demonstrate that this stylized fact is observed across countries and industries as well as for a given borrower over time and is not explained by a different composition of borrowers issuing debt during periods of high sovereign yields or by the relationship between corporate and sovereign credit ratings. We show that even if we exclude high-yield episodes that accompany financial crises and IMF programs, the sensitivity of corporate yields to sovereign yields is lower when sovereign yields are high. We propose a simple information model that rationalizes our empirical observations: when sovereign yields are high and more volatile, corporate yields are less sensitive to sovereign yields.
Why was recovery from the euro area crisis delayed for a decade? The explanation lies in the absence of credible and timely policies to backstop financial intermediaries and sovereign debt markets. In this paper we add light and color to this analysis, contrasting recent experience with the 1992-3 crisis in the European Monetary System, when national central banks and treasuries more successfully provided this backstop. In the more recent episode, the incomplete development of the euro area constrained the ability of the ECB and other European institutions to do likewise.
Published Articles (Refereed Journals and Volumes)
We examine currency denomination in a large sample of private international bonds issued by small country firms. We find a substantive and persistent increase in the share of international bond placements denominated in issuers’ home currencies, potentially mitigating currency mismatch. This trend appears to have accelerated since the global financial crisis. We find that global financial conditions as well as issuers’ country inflation history determine the change in home currency issuance. We present a model illustrating how temporary changes in relative currency-denomination costs can lead to persistent changes in the currency composition of bond issuance.
We study the transmission of financial shocks across borders through international bank connections. Using data on cross-border interbank loans among 6,000 banks during 1997-2012, we estimate the effect of banks’ direct and indirect exposures to banks in countries experiencing systemic banking crises on profitability, credit, and the performance of borrower firms. We show that direct exposures to crises reduce bank returns and tighten credit conditions through lower loan volumes and higher
rates on loans. Indirect crisis exposures amplify these effects. Crisis exposures reduce firm growth and investment even in countries not experiencing banking crises themselves, thus transmitting shocks across borders.
We explore the question of optimal aggregation level for stress testing models when the stress test is specified in terms of aggregate macroeconomic variables, but the underlying performance data are available at a loan level. Using standard model performance measures, we ask whether it is better to formulate models at a disaggregated level (“bottom up”) and then aggregate the predictions in order to obtain portfolio loss values or is it better to work directly with aggregated models (“top down”) for portfolio loss forecasts. We study this question for a large portfolio of home equity lines of credit. We conduct model comparisons of loan-level default probability models, county-level models, aggregate portfolio-level models, and hybrid approaches based on portfolio segments such as debt-to-income (DTI) ratios, loan-to-value (LTV) ratios, and FICO risk scores. For each of these aggregation levels we choose the model that fits the data best in terms of in-sample and out-of-sample performance. We then compare winning models across all approaches. We document two main results. First, all the models considered here are capable of fitting our data when given the benefit of using the whole sample period for estimation. Second, in out-of-sample exercises, loan-level models have large forecast errors and underpredict default probability. Average out-of-sample performance is best for portfolio and county-level models. However, for portfolio level, small perturbations in model specification may result in large forecast errors, while county-level models tend to be very robust. We conclude that aggregation level is an important factor to be considered in the stress-testing model design.
In this paper, we propose a procedure that generates measures of connectedness between individual firms and for the system as a whole based on information observed only at the firm level; i.e., no explicit linkages are observed. We apply our procedure to large U.S. bank holding companies. We show how bank outcome variables of interest can be decomposed, including with mixed-frequency models, for network analysis to measure connectedness across firms. Network analysis of these decompositions produces measures that could be of use in financial stability monitoring as well as the analysis of individual firms’ linkages.
There is no consensus in the empirical literature on the direction in which U.S. monetary policy affects cross-border bank lending. We find robust evidence that the impact of the U.S. federal funds rate on cross-border bank lending in a given period depends on the prevailing international capital flows regime and on the level of the two main components of the federal funds rate: macro fundamentals and monetary policy stance. During episodes in which bank lending from advanced to emerging economies is booming, the relationship between the federal funds rate and cross-border bank lending is positive and mostly driven by the macro fundamentals component, which is consistent with a search-for-yield behavior by internationally-active banks. In contrast, during episodes of stagnant growth in bank lending from advanced to emerging economies, the relationship between the federal funds rate and bank lending is negative, mainly due to the monetary policy stance component of the federal funds rate. The latter set of results is driven by the lending to emerging markets, which is consistent with the international bank-lending channel and flight-to-quality behavior by internationally-active banks.
We uncover a new channel through which international finance is related to trade: the formation of international bank linkages increases exports. Bank linkages are measured for each pair of countries in each year as a number of bank pairs in these two countries that are connected through cross-border syndicated lending. Using a gravity approach to model trade for 66 countries over 24 years with a full set of fixed effects (source-year, target-year, source-target), we find that new connections between banks in a given country-pair lead to an increase in trade flows between these countries in the following year and to trade diversions from countries competing for similar imports. We conjecture that the mechanism for this effect is the role bank linkages play in reducing export risk and present evidence supporting this conjecture. In particular, using industry-level trade data and controlling for country-pair-year and industry fixed effects, we find that new bank linkages have larger impacts on trade in industries which tend to be subject to more export risk. For U.S. banks, we can show that bank linkages are positively associated with foreign letter of credit exposures.
Greater financial integration between core and peripheral EMU members had an effect on both sets of countries. Lower interest rates allowed peripheral countries to run bigger deficits, which inflated their economies by allowing credit booms. Core EMU countries took on extra foreign leverage to expose themselves to the peripherals. The result has been asset-price bubbles and collapses in some of the peripheral countries, area-wide banking crisis, and sovereign debt problems. We analyze the geography of international debt flows using multiple data sources and provide evidence that after the euro’s introduction, Core EMU countries increased their borrowing from outside of EMU and their lending to the EMU periphery.
Regional wage differences in China appear to be persistent and even to have grown over the past two decades. We study potential explanations for this phenomenon. After adjusting for the difference in the cost of living across provinces, we find that some of the cross-province differences in real wages could be related to the quality of labour, industry composition and geographic location of provinces. These factors, taken together, explain approximately half of the cross-province real wage variation. Interestingly, we find that interprovincial government transfers have not offset regional wage differences during the time period we consider. We also demonstrate that interprovincial migration, while driven in part by levels and changes in wage differences across provinces, did not help offset these differences. These results are consistent with findings in the literature that cross-province labour mobility in China is still limited.
We use input-output data to compute the share of imports and commodities in personal consumption and fixed investment in the United States (US). We show that for the US, a large high-income economy, the shares of local content and of non-commodity content are rather small in categories that are not directly related to commodities or imported goods. Overall, about 82% of expenditures by US consumers go to goods that are made entirely domestically and from domestic imports. Our measures represent an upper bound on the computed shares of imports from a specific region, because we use a conventional, rather than a value added, measure of trade flows.
We examine the composition and drivers of cross-border bank lending between 1995 and 2012, distinguishing between syndicated and non-syndicated loans. We show that on-balance sheet syndicated loan exposures, which account for almost one third of total cross-border loan exposures, increased during the global financial crisis due to large drawdowns on credit lines extended before the crisis. Our empirical analysis of the drivers of cross-border loan exposures in a large bilateral dataset leads to three main results. First, banks with lower levels of capital favor syndicated over other kinds of cross-border loans. Second, borrower country characteristics such as level of development, economic size, and capital account openness, are less important in driving syndicated than non-syndicated loan activity, suggesting a diversification motive for syndication. Third, information asymmetries between lender and borrower countries became more binding for both types of cross-border lending activity during the recent crisis.
Using panel data from the Chinese Industrial Surveys of Medium-sized and Large Firms for 2000–2006, we show that the presence and the magnitude of technological spillovers from FDI in the People’s Republic of China are affected by the source of FDI, by the ownership type of a firm in consideration, as well as by industrial and provincial characteristics. Private firms are more likely to benefit from horizontal spillovers than other domestic firms, but are less likely to benefit from vertical ones. Presence of state-owned firms in the industry impedes technological spillovers in a way that is consistent with diversion of linkages from private to state-owned firms. Finally, horizontal spillovers are larger in industries that are more technologically sophisticated.
Analyzing university faculty and graduate student data for the top-ten U.S. economics departments between 1987 and 2007, we find that there are persistent differences in gender composition for both faculty and graduate students across institutions and that the share of female faculty and the share of women in the entering PhD class are positively correlated. We find, using instrumental variables analysis, robust evidence that this correlation is driven by the causal effect of the female faculty share on the gender composition of the entering PhD class. This result provides an explanation for persistent underrepresentation of women in economics, as well as for persistent segregation of women across academic fields.
We develop a model predicting two channels through which creditor protection enhances the performance of stock prices: (1) The probability of a liquidity crisis leading to a binding investment-finance constraint falls with a strong protection of creditors; (2) The stock prices under the investment-constrained regime increase with better protection of creditors. We find empirical support for both predictions using data on stock market performance, amount and cost of credit, and creditor rights protection for 52 countries over the period 1980-2008. In particular, we find that better creditor protection is correlated across countries with lower average stock market volatility, crises are more frequent in countries with poor creditor protection. Using propensity score matching we also show that during crises stock market returns and investment fall by more in countries with poor creditor protection.
Recent financial crisis demonstrated that the banking system can be a pathway for shock transmission. In this paper, we analyze how banks transmit shocks that hit the debt market to their borrowers. Our paper shows that when banks experience a shock to the cost of their bond financing, they pass a portion of their extra costs or savings to their corporate borrowers. While banks do not offer special protection from bond market shocks to their relationship borrowers, they also do not treat all of them equally. Relationship borrowers that are not bank-dependent are the least exposed to bond market shocks via their bank loans. In contrast, banks pass the highest portion of the increase in their cost of bond financing to their relationship borrowers that rely exclusively on banks for external funding. These findings show that banks put more weight on the informational advantage they have over their relationship borrowers than on the prospects of future business with these borrowers. They also show a potential side effect of the recent proposals to require banks to use CoCos or other long-term funding.
In this paper we demonstrate that private firms in China have more difficult access to external finance than state owned firms and argue that they make adjustments to reduce their demand for external funds. In particular, we show that private firms have lower levels of inventory and trade credit and that these levels decrease with the difficulty of obtaining external finance. Nevertheless, we find no evidence that these lower levels of inventory and trade credit lead to lower productivity or profitability.
Currency Composition of International Bonds: The EMU Effect
Journal of International Economics 88(1), September 2012, 134-149 | With Spiegel
We analyze the impact that the launch of the EMU had on the currency denomination of private international bond issues in 1990-2006 using micro-level data. Our stylized model predicts that the introduction of the euro would lead to an increase in the share of euro-denominated debt and a decline in the share of dollar-denominated debt issued by firms located in countries outside both the United States and the euro area. Moreover, our model predicts that the euro effect would be particularly pronounced for nonfinancial firms. Our empirical
results are consistent with these predictions. In addition, we
find that among nonfinancial firms, the impact on new issuers is larger than on seasoned issuers. Extending the model to allow for differences in issuance volumes across future monetary union countries prior to integration, we also predict larger increases in euro-denominated issuance among firms from smaller monetary union countries. We confirm this prediction for international bond issues by euro-area firms.
Bank Relationships, Business Cycles, and Financial Crises
Journal of International Economics 88(2), January 2012, 312-325
The importance of information asymmetries in the capital markets is commonly accepted as one of the main reasons for home bias in investment. The effects of such asymmetries may potentially be reduced through relationships between banks established through bank-to-bank lending. To analyze the dynamics of formation of such relationships during 1980-2009, I construct a global banking network of 7938 banking institutions from 141 countries. I find that recessions and banking crises tend to have negative effects on the formation of new connections and that these effects are not the same for all countries or all banks. I also find that the global financial crisis of 2008-09 had a large negative impact on the formation of new relationships in the global banking network, especially by large banks, which were previously immune to effects of banking crises and recessions.
Did Foreign Direct Investment Put an Upward Pressure on Wages in China?
IMF Economic Review 59(3), November 2011, 404-430 | With Long
In this paper we study the extent to which foreign direct investment (FDI) could have contributed to recent increase in wages in China. Using a World Bank survey data set of 1500 Chinese enterprises conducted in 2002, we find that the presence of FDI has both direct and indirect effects on wages of skilled workers, while it does not
appear to affect wages of production workers. Moreover, we find that the indirect effect of the FDI presence on wages of skilled workers is limited to private firms. We further find that observed quality of skilled workers in state owned enterprises (SOEs) declines
in the presence of FDI in the same industry and region. We discuss potential reasons for such discrepancy in the FDI effects on private firms’ and SOEs’ labor practices. These findings highlight the relevance of labor market institutions in determining FDI spillovers.
Are There Productivity Spillovers from Foreign Direct Investment in China?
Pacific Economic Review 16(2), Spring 2011, 135-153 | With Long
We review previous literature on productivity spillovers of foreign direct investment (FDI) in China and conduct our own analysis using a firm-level data set from a World Bank survey. We find that the evidence of FDI spillovers on the productivity of Chinese domestic firms is mixed, with many positive results largely due to aggregation bias or failure to control for endogeneity of FDI. Attempting over 6000 specifications which take into account forward and backward linkages, we fail to find evidence of systematic positive productivity spillovers from FDI in China.
What Are the Sources of Financing for Chinese Firms?
In The Evolving Role of Asia in Global Finance, 9, ed. by Guonan Ma, Vikas Kakkar, and Yin-Wong Cheung | Emerald Group Publishing, 2011 | With Long
Despite China’s rapid economic growth in the past three decades, many of the reforms have not yet reached the financial sector. It is common knowledge that external financing in China is mostly limited to state-owned enterprises (SOEs) and is hard to obtain for smaller private firms. In this paper we take a closer look at internal and external, formal and informal, financing sources of Chinese firms during the period of rapid economic reform from 1997 to 2006. To this end we analyze balance-sheet data from the Chinese Industrial Surveys of Medium-sized and Large Firms for 2000-2006 and survey data from the Large-Scale Survey of Private Enterprises in China conducted in 1997, 2000, 2002, 2004, and 2006.
The following stylized facts emerge from our analysis: (1) State-owned firms continue to enjoy significantly more generous external finances than other types of Chinese firms. (2) Chinese private firms have resorted to various ways of overcoming financial constraints, including reliance on the increasingly more mature informal financial markets, cost savings through lower inventory and other working capital requirements, and greater reliance on retained earnings. (3) There are substantial variations in financial access among private firms, while the small private firms face more financial constraints, the more established large private firms seem to have access to finances that are more equal to their SOE counterparts. (4) Although not as accessible as for SOEs, the Chinese formal financial sector does provide Chinese private firms with substantial financial resources, especially for their short-term needs during daily operations. And, (5) the most pressing financial constraint facing Chinese private firms is their limited ability to secure long-term funds to invest for growth, and resolving this issue should be one of the top goals of financial reforms in China.
Foreign Direct Investment and Incentives to Innovate and Imitate
Scandinavian Journal of Economics 111(4), December 2009, 835-861 | With Brambilla and Long
We propose a new channel of FDI spillovers on domestic firms, which operates through imitation of original products. Domestic heterogeneous firms may not introduce any new products, introduce a new product line (innovate), or develop a variety that is a close substitute to an existing product line (imitate). The presence of foreign firms generates incentives for imitation because they introduce original products that are vertically differentiated from domestic products. Using firm-level panel data for China, we find that increased FDI presence in a given industry leads to more imitation, but not necessarily more innovation, by domestic firms.
Currency crises of the past decade highlighted the importance of balance-sheet effects of currency crises. In credit-constrained markets such effects may lead to further declines in credit. Controlling for a host of fundamentals, we find a systematic decline in foreign credit to emerging market private firms of about 25% in the first year following currency crises, which we define as large changes in real value of the currency. This decline is especially large in the first five months, lessens in the second year and disappears entirely by the third year. We identify the effects of currency crises on the demand and supply of credit and find that the decline in the supply of credit is persistent and contributes to about 8% decline in credit for the first two years, while the 35% decline in demand lasts only five months.
Do Banks Price Their Informational Monopoly?
Journal of Financial Economics 93(2), August 2009, 185-206 | With Santos
Modern corporate finance theory argues that although bank monitoring is beneficial to borrowers, it also allows banks to use the information they gain through monitoring to “hold-up” borrowers for higher interest rates. In this paper, we seek empirical evidence for this information hold-up cost. Since new information about a firm’s creditworthiness is revealed at the time of its first issue in the public bond market, it follows that after firms undertake their bond IPO, banks with an exploitable information advantage will be forced to adjust their loan interest rates downwards, particularly for firms that are revealed to be safe. We test this hypothesis by comparing banks’ loan pricing policies before and after borrowers gain access to public bond market. To isolate the information hold-up cost we further compare the change in the loan policies between borrowers that already had a credit rating at the time of their bond IPO and borrowers that get their first credit rating at that time. Our findings show that firms are able to borrow at lower interest rates after their bond IPO and that these savings are larger for safer firms. We also find that, among safe firms, those that get their first credit rating at the time of their bond IPO benefit from larger interest rate savings than those that already had a credit rating. These findings provide support for the hypothesis that banks price their informational monopoly. Finally, we find that while entering the public bond market may reduce these informational rents, it is also costly to firms because they have to pay higher underwriting costs on their IPO bond.
This paper uses survival analysis to investigate the timing of a firm’s decision to issue for the first time in the public bond market. We find that firms that are more creditworthy and have higher demand for external funds issue their first public bond earlier. We also find that issuing private bonds or taking out syndicated loans is associated with a faster entry to the public bond market. According to our results, the relationships that firms develop with investment banks in connection with their private bond issues and syndicated loans further speed up their entry to the public bond market. Finally, we find that a firm’s reputation has a “U-shaped” effect on the timing of a firm’s bond IPO. Consistent with Diamond’s reputational theory, firms that establish a track record of high creditworthiness as well as those that establish a track record of low creditworthiness enter the public bond market earlier than firms with intermediate reputation.
We use micro-level data to analyze emerging markets’ private sector access to international debt markets during sovereign debt crises. We find that these crises are systematically accompanied by a decline in foreign credit to domestic private firms, both during debt renegotiations and for over two years after restructuring agreements are reached. This decline is large, statistically significant, and robust. We find that this effect is concentrated in the nonfinancial sector and is different for firms in the exporting and in the non-exporting sectors. We also find that the magnitude of the effect depends on the type of debt restructuring agreement.
The costs of debt crises are not invariant to the foreign debt instrument composition: bank loans or bonds. The lending boom of the 1990s witnessed considerable variation over time and across countries in the debt instrument used by emerging market (EM) borrowers. This paper tests how macroeconomic fundamentals affect the composition of international debt instruments used by EM borrowers. Analysis of micro-level data using ordered probability model shows that macroeconomic fundamentals explain a significant share of variation in the ratio of bonds to loans for private borrowers, but not for the sovereigns.
In order to explore how credit ratings may affect financial markets, we analyze a global game model of debt roll-over in which heterogeneous investors act strategically. We find that the addition of the rating agency has a non-monotonic effect on the probability of default and the magnitude of the response of capital flows to changes in fundamentals. We also establish that introducing a rating agency can bring multiple equilibria to a market that otherwise would have a unique equilibrium.
Flight to Quality: Investor Risk Tolerance and the Spread of Emerging Market Crises
In International Financial Contagion, ed. by Classens & Forbes | Kluwer, 2001 | With Eichengreen and Mody
World Experience in Fighting High Inflation
Vestnik Moscow State University 3, 1996, (in Russian)
Foreign Direct Invesment in China: Winners and Losers
Forthcoming in Encyclopedia of International Economics and Global Trade, Vol 3: Foreign Direct Investment and the Multinational Enterprise, ed. by Mariana Spatareanu. Singapore: World Scientific | With Xu
This paper surveys literature on impact of foreign direct investments (FDI) on host country’s labor market, including employment, wages, labor productivity, skill premium, and inequality. Meta-analysis of empirical findings suggests that there is solid consensus with respect to wages: in both developing and developed countries FDI leads to higher wages in target firms and industries. Majority of the papers also find positive productivity spillovers as well as increase in skill premium as a result of FDI, especially in developing economies. We analyze all the findings together to address possible mechanisms of FDI effects on labor in target firms, in competing firms, and in vertically related firms. We present a stylized model that is consistent with many empirical regularities found in meta-analysis of empirical literature.
Since the Global Crisis, cross-border lending among banks and its role in the transmission of financial shocks have gained a lot of attention. This column describes evidence from direct and indirect lending exposures among a large number of banks. The findings show that a larger number of exposures to banks in countries experiencing a systemic banking crisis reduces profitability and the supply of new credit. Both direct and indirect connections have economically significant effects, supporting the notion that interconnected systems are prone to shock transmission.
Large flows of bank lending from core countries in the Eurozone to the periphery lead to large financial imbalances. This column explains what motivated such financial flows. With the advent of the Eurozone, banks in core countries gained relative advantage in lending to the periphery, making such lending very attractive. They also served as intermediaries for financial flows from outside the Eurozone to the periphery. Now – five years since the start of the euro crisis – Eurozone financial markets remain segmented.
Finding reliable indicators that predict the likelihood and severity of crises across countries has been a frustrating quest for economists. This column suggests that countries with better creditor protection suffer less when a crisis hits.
Beggar-thy-neighbor; Currency; Currency appreciation and depreciation; Currency devaluation and revaluation; Dirty float; Elasticity; Static expectations; Overshooting; Foreign reserves; Economic sterilization; Discounted present value; Stocks and flows
In International Encyclopedia of the Social Sciences, 1, 2nd edition, ed. by W.A. Darity, Jr. | Detroit: Macmillan Reference U.S.A., 2008
Book Review: Sound Policies for Emerging Markets’ Financial Stability