Research

Business Complexity and Risk Management: Evidence from Operational Risk Events in U.S. Bank Holding Companies (with Anna Chernobai and Ali Ozdagli) - Journal of Monetary Economics, Volume 117, January 2021, Pages 418-440

Abstract: Recent regulatory proposals tie a financial institution’s systemic importance to its complexity. However, little is known about how complexity affects banks’ risk management. Using the 1996–1999 deregulations of U.S. banks’ nonbanking activities as a natural experiment, we show that banks’ business complexity increases their operational risk. This result is driven by banks that had been constrained by regulations, compared with other banks and also with nonbank financial institutions that were never subject to these regulations. We provide evidence that managerial failure underlying these events offsets benefits of strategic risk taking.

Multinationals and Uncertainty: The Role of Internal Capital Markets

Abstract: Multinational enterprises (MNEs) borrow capital globally and reallocate it internally. This paper studies how external lenders at the parent and subsidiary levels of an MNE interact through its internal capital market (ICM). Due to agency problems faced by MNEs and their external lenders, I show that an MNE can allocate an optimal portion of its external debt at the subsidiary level for delegated monitoring when local lenders have information advantages over the (foreign) shareholders of a subsidiary. Given the debt structure, I then study how the parent- and subsidiary-level external debt interacts via the ICM in response to local country-level shocks both theoretically and empirically. Using the rise of uncertainty in the UK during an early period of Brexit as a natural experiment, I provide evidence that MNEs can lower the portion of external debt allocated at the subsidiary level when facing local shocks that enhance the monitoring incentive of subsidiary-level external lenders. Thus, MNEs respond by raising parent-level external debt for their affected subsidiaries, which tends to be cheaper. Meanwhile, the subsidiaries lower their external borrowing in exchange for new capital provided internally via the ICM. Such substitution of external debt across the ICM improves the debt structure of MNEs and can stabilize the deleveraging pressure caused by a local country-level shock.

Uncertainty, Stock Prices, and Debt Structure (with Ali Ozdagli) - Dallas Fed blog post on this paper

Abstract: Despite the recognized importance of debt structure in transmitting economic shocks, we know little about its role in transmitting uncertainty. We find that bank debt reduces stock price sensitivity to policy uncertainty, unlike non-bank debt. This mitigating effect comes from cash-flow insolvent firms, consistent with the idea that they particularly value renegotiability of bank debt. Using high-frequency methods, we address challenges in identifying policy uncertainty shocks, focusing on the 2018-2019 U.S.-China trade policy uncertainty and on monetary-policy-related uncertainty around FOMC announcements. Our results suggest that bank debt provides insurance and flexibility for shareholders of distressed firms, especially during turbulent times.

The Fiscal Multiplier and World War II: A Revisit from the Stock Market Perspective

Abstract: Stock returns of the defense industry have been as used as a novel approach in identifying government spending shocks and tend to yield an above-unity fiscal multiplier during the post-Korean War period. In this study, I identify the public aircraft and shipbuilding companies as the defense sector of the U.S. stock market and apply the stock market approach to estimate the fiscal multiplier associated with WWII, the largest fiscal stimulus episode of the modern U.S. history. Based on a monthly sample from 1936 to 1947, I find that the output elasticity with regards to total government spending is around 0.276 during the WWII era, which is very close of the 0.3 output elasticity reported from the post-Korean War sample. I also observe persistent responses in government spending and real output to innovations in the excess returns of defense sector, a feature consistent with the findings of the stock market approach and suggesting the existence of expectation effects at a longer horizon that has yet to be accounted for by the main approaches of the literature. Due to the special economic environments of WWII characterized by a high government spending share, the 0.276 output elasticity implies a fiscal multiplier of 0.72, which is in turn consistent with the multiplier estimated via defense news. Upon comparing the performance of the excess returns and defense news on an overlapping sample, I present evidence emphasize the importance of the expectation effects at a longer horizon. In specific, I discover that the shape of responses to the excess returns and defense news can replicate each other by forwarding the defense news and lagging the excess return series.

Multinationals and Exchange Rates: Evidence from Switzerland - Clausen Center 2022 Research Grant Award

Abstract: In this article, I present the first-step evidence that foreign affiliates of multinational enterprises propagate the transmission of international monetary shocks to domestic inflation dynamics. I further highlight the importance that ownership matters in the usage of imported inputs due to potential organizational bonds between foreign affiliates and the intangible assets of their parents. When propagating the transmission of international monetary shocks, imported inputs themselves do not give a complete picture. Rather, the interaction between ownership and imported inputs matters. Utilizing a novel database that splits the Inter-Country Input-Output tables along the dimension of ownership, I find that foreign affiliates have an influential presence in the domestic sales of the tradable sectors of major developed economies. I also confirm that foreign affiliates tend to use more imports compared with the domestic-owned firms in the same industry. However, there is mixed evidence on foreign affiliates systematically selecting into import intensive industries. Using the 2015 Swiss franc appreciation as a natural experiment, I show that foreign affiliates in Switzerland gained market share following the appreciation, compared with not only the domestic-owned firms, but also the domestic-owned multinational enterprises in the same industry. This finding is consistent with the narrative that the foreign affiliates propagated the deflationary shock by adjusting prices downward further due to the cheaper imports following the appreciation. I also provide evidence that tradable sectors in Switzerland with a higher import intensity gained relative market share from the appreciation. But the positive effect of import intensity on domestic sales is significant only for the foreign-owned sectors.

Bank Holding Companies and Risk Taking: The Role of Internal Capital Markets (with Kebin Ma and Jing Ye)

The Anti-Competitive Effect of Input Tariff Liberalization (with Petr Martynov and Yipei Zhang)