Credit Supply and the Price of Housing

(with Jean Imbs)


We show that since 1994, branching deregulations in the U.S have significantly affected the supply of mortgage credit, and ultimately house prices. With deregulation, the number and volume of originated mortgage loans increase, while denial rates fall. But the deregulation has no effect on a placebo sample, formed of independent mortgage companies that should not be affected by the regulatory change. This sharpens the causal interpretation of our results. Deregulation boosts the supply of mortgage credit, which has significant end effects on house prices. Interestingly, the fraction of securitized mortgage loans remains unchanged through the process. We find evidence house prices rise with branching deregulation, particularly so in Metropolitan Areas where construction is inelastic for topographic reasons. We document these results in a large sample of counties across the U.S. We also focus on a reduced cross-section formed by counties on each side of a state border, where a regression discontinuity approach is possible. Our conclusions are strengthened.


Strategic Default and Equity Risk Across Countries (with Enrique Schroth and Philip Valta)

LECG Prize for Best Conference Paper, EFA Bergen, August 2009


We test whether the firm’s systematic equity risk reflects shareholders’ incentives to default strategically on its debt. We use a real options model to relate shareholders’ strategic default behavior to frictions in the debt renegotiation procedure. We test the model’s predictions with an international cross-section of stocks, exploiting the cross-country exogenous variation of bankruptcy procedures. We find that the equity beta increases as debt is more strictly enforced. Moreover, the equity beta decreases with liquidation costs and shareholders’ bargaining power, and the sensitivity of this relationship weakens as the country’s debt renegotiation procedures become more creditor friendly.


Agency Problems and Endogenous Economic Fluctuations 


This paper proposes a theory of investment fluctuations where the source of the oscillating dynamics is an agency problem between financiers and entrepreneurs. A central tenet of the theory is that investment decisions depend upon entrepreneurs’ initiative to select investment projects ex-ante, and financiers’ incentive to control entrepreneurs ex-post. Too much control discourages entrepreneurial incentive to initiate new investment, while too little control jeopardizes its productivity. This trade-off generates investment dynamics that mimic those of a standard credit frictions model, in which more entrepreneurial net worth leads to higher investment. The same trade-off is capable of generating endogenous reversal of investment booms, induced by an ongoing deterioration of project profitability. Investment fluctuations take place even though no external shocks hit the economy, and even though agents are perfectly rational.


House Price Dynamics with Heterogeneous Expectations

(with Michael Song)


We use a user-cost model to study how dispersed information among housing market participants affects the equilibrium house price. In the model, agents are disparately informed about local economic conditions, consume housing services, and speculate on price changes. Information dispersion leads agents to have heterogeneous expectations about housing demand and prices. Optimists, who expect high house price growth, buy in anticipation of capital gains; pessimists, who expect capital losses, prefer to rent. As pessimistic expectations are not incorporated in the price of owned houses, the equilibrium price is higher and more volatile relative to the benchmark case of common information. We present evidence supporting the model's predictions in a panel of US cities. 



Short-Sale Constraints, Higher Order Expectations and Asset Pricing

(with Michael Song).

We study the effects of short-sale constraints on asset prices using a dynamic noisy rational expectation model with differential information between investors. We find that differences in investors’ posterior beliefs lead asset prices to deviate from their fundamental value and the size of the price misalignment is increasing in expectation differences. We also find that if investors' decisions depend on the expectation of other investors' expectations, higher order beliefs reduces the degree of information heterogeneity and limit the extent of asset mispricing. This is so because higher order expectations force investors to put more weight on public signals and less on private signals which, in the presence of short sale constraints and difference of opinions, is the main reason why asset prices deviate from their fundamental values.


An Empirical Reassessment of the Relationship between Finance and Growth


This paper re-examines the empirical relationship between financial development and economic growth. It presents evidence based on an a variety of econometric methods and two standard measures of financial development: the level of liquid liabilities of the banking system and the amount of credit issued to the private sector by banks and other financial institutions. There are two main findings. First, cross section and panel data instrumental variables regressions reveal that financial development and economic growth are correlated but financial development does not cause economic growth. Second, using a procedure appropriately designed to estimate long-run relationships in a panel with heterogeneous slope coefficients, there is evidence that the finance-growth relationship is quite heterogeneous across countries and no clear indication that finance spurs economic growth.


Reconsidering the Role of Money for Output, Prices and Interest Rates

(with Paolo Giordani) Journal of Monetary Economics, 2009, 56 (3)


New Keynesian models of monetary policy predict no role for monetary aggregates, in the sense that the level of output, prices, and interest rates can be determined without knowledge of the quantity of money. This paper evaluates the empirical validity of this prediction by studying the effects of shocks to monetary aggregates using a VAR. Shocks to monetary aggregates are identified by the restrictions suggested by New Keynesian monetary models. Contrary to the theoretical predictions, shocks to broad monetary aggregates have substantial and persistent effects on output and prices.