Essays in macroeconomics and financial markets.

Abstract

In this dissertation, we study the interaction of financial markets and the macroeconomy. In Chapter 1, we examine the quantitative importance of financial market shocks in accounting for business cycle fluctuations. We emphasize the role financial markets play in reallocating funds from cash-rich, low productivity firms to cash-poor, high productivity firms. Using evidence on financial flows at the firm level, we find that for publicly traded firms (in Compustat), almost all investment is financed internally. However, using an alternative data source (Amadeus), we find that most investment by privately held firms is financed through borrowing. Motivated by these observations, we build a quantitative model featuring publicly and privately held firms that face collateral constraints and idiosyncratic risk over productivity as well as non-financial linkages. In our calibrated model, we find that a shock to the collateral constraints which generates a one standard deviation decline in the debt-to-asset ratio leads to a 0.5% decline in aggregate output on impact, roughly comparable to the effect of a one standard deviation shock to aggregate productivity in a standard real business cycle model. In this sense, we find that disturbances in financial markets are a promising source of business cycle fluctuations when non-financial linkages across firms are sufficiently strong. In Chapter 2, we analyze the causes of financial crises and policies designed to mitigate their effects. we provide new evidence that the capital structure of financial institutions is significantly more illiquid than that of non-financial businesses. We develop a theory in which such differences in capital structure arise from the differences in information lenders have about the assets of financial and non-financial businesses. We use the theory to show that the illiquid capital structure used by financial institutions leads such institutions to be inherently fragile and that government interventions during a crisis, such as bailouts, are not desirable. In Chapter 3, we study policies intended to remedy collapses in secondary loan markets. Loan originators often securitize some loans in secondary loan markets and hold on to others. New issuances in such secondary markets collapse abruptly on occasion, typically when collateral values used to secure the underlying loans fall and these collapses are viewed by policymakers as inefficient. We develop a dynamic adverse selection model in which small reductions in collateral values can generate abrupt inefficient collapses in new issuances in the secondary loan market by affecting reputational incentives. We find that a variety of policies intended to remedy market inefficiencies do not help resolve the adverse selection problem.