Research

Banks hold long-duration securities because these assets hedge fluctuations in the cash flows generated by the deposit franchise: short rates compress deposit margins, but increase long-bond prices. This hedging motive, however, exposes banks to large mark-to-market losses when rates rise and can tighten liquidity and solvency constraints, increasing vulnerability to runs of the kind observed in March 2023. Using U.S. bank data, we document a non-monotonic relationship between banks’ shares of long credit-risk-free securities and marked-to-market equity values, indicating that banks with an intermediate ratio of equity to uninsured deposits hold a higher share of long bonds. We interpret this evidence through a continuous-time model in which banks optimally choose a portfolio between a short bond and a long bond, and are subject to state-dependent run risk modeled as a Poisson termination shock that destroys future franchise value when the bank becomes insolvent. The resulting endogenous run hazard generates state-dependent effective risk tolerance and delivers testable implications for dividend payouts that match key patterns in the data. The model also provides a quantitative framework to evaluate interest-rate-risk policies, including capital and liquidity requirements and regulatory limits on duration exposure.

The aftermath of sovereign default episodes for emerging and developed economies since the 1980s underscores the crucial role of the legal jurisdiction under which debt is issued. This paper provides a quantitative framework for evaluating the trade-offs between issuing domestic and foreign-law bonds from the sovereign’s perspective. While foreign-law bonds offer stronger legal protections for investors and thus command higher prices, domestic-law bonds are more easily restructured after default. We document differences in the maturity structures of both types of debt for a set of emerging market economies. Then, we disentangle the effects of differences in maturities and recovery rates in shaping the composition of the sovereign’s portfolio. The model reveals that when recovery rates are similar, the sovereign favors bonds with shorter maturities. However, when recovery rates diverge, the sovereign prefers to issue the asset with a higher recovery rate. The dominant factor hinges on the magnitude of recovery rate differences between foreign-law and domestic-law debt after default.

We study a sovereign’s choice of whether to disclose information about its repayment capacity to international lenders in a 3-period Eaton and Gersovitz (1981) environment. Under full disclosure, debt is priced at actuarially fair rates for each type; under non-disclosure, a pooling equilibrium generates cross-subsidization across types. We show that non-disclosure is preferred when the probability of being the low type is small: the adverse selection discount the high type bears under pooling is then small, making opacity relatively cheap. Moreover, non-disclosure is preferred when deadweight losses from default are small: the insurance value of pooling then dominates the pricing gains from transparency. Two pieces of evidence support the framework. Mexico’s pre-1995 reserve-disclosure regime illustrates a durable, pre-committed disclosure rule consistent with the model. Using IMF Data Standards Initiatives, we document that no country has ever moved to a lower transparency tier, that countries facing higher recession risk are more often observed to adopt transparency tiers, an association consistent with the model’s threshold comparative static, and that early adopters exhibit, for two of the three tier margins, more dispersed residualized issuances than eligible non-adopters, in a direction consistent with the model.

We develop a model of search in OTC markets with asymmetric information and trade occurring under double-sided uncertainty over asset quality, where holding the asset does not necessarily translate into knowing its quality. This leads to deterioration of market information conditions over subsequent trades, causing sellers to become more pessimistic even though aggregate asset quality remains unchanged. If re-trade opportunities are frequent, information in the economy becomes coarser, hindering market liquidity and volume of trade. Additionally, if good assets are not originated at a higher volume than what is currently being traded in the market, only the most pessimistic sellers will trade in equilibrium.

This paper investigates how sectoral linkages amplify or diminish misallocation at the intensive and extensive margins. Our analysis is based on a multisector general equilibrium model with input–output linkages, heterogeneous entrepreneurial abilities, and endogenous occupational choice. Distortions affect the intensive use of production inputs and they also impact the agents’ occupational decisions, misallocating the mass and type of entrepreneurs in different sectors of production. When the most distorted sectors are upstream (downstream), input–output linkages amplify (diminish) the loss from entrepreneurial misallocation. We calibrate the model to the US and quantify the output losses from sectoral corporate taxes, decomposing the role of networks and the extensive margin decisions. We find that sectoral linkages quadruple the loss from the misallocation of entrepreneurs. We study an entry subsidy program, showing that it should target those sectors whose marginal entrepreneurs suffer larger profit losses, even if they are not necessarily the most distorted.