We analyze how systemic cyber risk relates to the financial cycle and show that the potential impact of a cyber attack is systematically greater during stressed financial conditions. This is true over the past two decades and particularly at the onset of the COVID-19 pandemic, when changes in payment activity increased vulnerability by approximately 50 percent relative to the rest of 2020 through more concentration and intraday liquidity stress. We evaluate the effectiveness of policy interventions used to stabilize markets at mitigating cyber vulnerability. We argue that cyber and other financial shocks cannot be treated as uncorrelated vulnerabilities and policy solutions for cyber need to be calibrated for adverse financial conditions.
Federal Reserve Bank of New York Economic Policy Review, forthcoming.
Inspired by experimental evidence, we amend the recursive utility model to let risk aversion decrease with the temporal horizon. Our pseudo-recursive preferences remain tractable and retain appealing features of the long-run risk framework, notably its success at explaining asset pricing moments. In addition, our model addresses two challenges to the standard model. Calibrating the agents' preferences to explain the equity premium no longer implies an extreme preference for early resolutions of uncertainty. Horizon-dependent risk aversion helps resolve key puzzles in finance on the valuation of assets across maturities and captures the term structure of equity risk premiums and its dynamics.
We model how a cyber attack may be amplified through the U.S. financial system, focusing on the wholesale payments network. We estimate that the impairment of any of the five most active U.S. banks will result in significant spillovers to other banks, with 38 percent of the network affected on average. The impact varies and can be larger on particular days and geographies. When banks respond to uncertainty by liquidity hoarding, the potential impact in forgone payment activity is dramatic, reaching more than 2.5 times daily GDP. In a reverse stress test, interruptions originating from banks with less than $10 billion in assets are sufficient to impair a significant amount of the system. Additional risk emerges from third party providers, which connect otherwise unrelated banks, and from financial market utilities.
In standard Walrasian macro-finance models, pecuniary externalities due to fire sales lead to excessive borrowing and insufficient liquidity holdings. We investigate whether imperfect competition (Cournot) improves welfare through internalizing the externality and find that this is far from guaranteed. Cournot competition can overcorrect the inefficiently high borrowing in a standard model of levered real investment. In contrast, Cournot competition can exacerbate the inefficiently low liquidity in a standard model of financial portfolio choice. Implications for welfare and regulation are therefore sector-specific, depending both on the nature of the shocks and the competitiveness of the industry.
American Economic Journal: Macroeconomics, 2022, 14(3), 508–542. [Ungated WP version]
We estimate a structural model of resource allocation on work hours of Federal Reserve bank supervisors to disentangle how supervisory technology, preferences, and resource constraints impact bank outcomes. We find a significant effect of supervision on bank risk and large technological scale economies with respect to bank size. Consistent with macroprudential objectives, revealed supervisory preferences disproportionately weight larger banks, especially post-2008 when a resource reallocation to larger banks increased risk on average across all banks. Shadow cost estimates show tight resources around the financial crisis and counterfactuals indicate that binding constraints have large effects on the distribution of bank outcomes.
We build a general equilibrium model with financial frictions that impede monetary policy transmission. Agents with heterogeneous productivity can increase investment by levering up, which increases liquidity risk due to maturity transformation. In equilibrium, more productive agents choose higher leverage than less productive agents, which exposes the more productive agents to greater liquidity risk and makes their investment less responsive to interest rate changes. When monetary policy reduces interest rates, aggregate investment quality deteriorates, which blunts the monetary stimulus and decreases asset liquidation values. This, in turn, reduces loan demand, decreasing the interest rate further and generating a negative spiral. Overall, the allocation of credit is distorted and monetary stimulus can become ineffective even with significant interest rate drops.
We identify and track over time the factors that make the financial system vulnerable to fire sales by constructing an index of aggregate vulnerability. The index starts increasing quickly in 2004, before most other major systemic risk measures, and triples by 2008. The fire‐sale‐specific factors of delevering speed and concentration of illiquid assets account for the majority of this increase. Individual banks' contributions to aggregate vulnerability predict other firm‐specific measures of systemic risk, including SRISK and ΔCoVaR. The balance sheet‐based measures we propose are therefore useful early indicators of when and where vulnerabilities are building up.
Why does the market discipline that financial intermediaries face seem too weak during booms and too strong during crises? This paper shows in a general equilibrium setting that rollover risk as a disciplining device is effective only if all intermediaries face purely idiosyncratic risk. However, if assets are correlated, a two-sided inefficiency arises: Good aggregate states have intermediaries taking excessive risks, while bad aggregate states suffer from costly fire sales. The driving force behind this inefficiency is an amplifying feedback loop between asset values and market discipline. In equilibrium, financial intermediaries inefficiently amplify both positive and negative aggregate shocks.
with Andrew Haughwout, Beverly Hirtle, Anna Kovner, David Lucca, and Matthew Plosser
The Federal Reserve is responsible for the prudential supervision of bank holding companies (BHCs) on a consolidated basis. Prudential supervision involves monitoring and oversight to assess whether these firms are engaged in unsafe or unsound practices, as well as ensuring that firms are taking corrective actions to address such practices. Prudential supervision is interlinked with, but distinct from, regulation, which involves the development and promulgation of the rules under which BHCs and other regulated financial intermediaries operate. This paper describes the Federal Reserve’s supervisory approach for large, complex financial companies and how prudential supervisory activities are structured, staffed, and implemented on a day‐to‐day basis at the Federal Reserve Bank of New York as part of the broader supervisory program of the Federal Reserve System. The goal of the paper is to generate insight for those not involved in supervision into what supervisors do and how they do it. Understanding how prudential supervision works is a critical precursor to determining how to measure its impact and effectiveness.
Federal Reserve Bank of New York Economic Policy Review, 2017, 23(1), 57–77.
We model an ‘anxious’ agent as one who is more risk averse with respect to imminent risks than with respect to distant risks. Based on a utility function that captures individual subjects’ behavior in experiments, we provide a tractable theory relaxing the restriction of constant risk aversion across horizons and show that it generates rich implications. We first apply the model to insurance markets and explain the high premia for short-horizon insurance. Then, we show that costly delegated portfolio management, investment advice, and withdrawal fees emerge as endogenous features and strategies to cope with dynamic inconsistency in intratemporal risk–return tradeoffs.
We analyze the effects and interactions of monetary policy tools that differ in terms of their timing and their targeting. In a model with heterogeneous agents, more productive agents endogenously expose themselves to higher interim liquidity risk by borrowing and investing more. Two inefficiencies impair the transmission of monetary policy: an investment- and a hoarding inefficiency. Heterogeneous agents respond disparately to ex-ante, conventional and ex-post, unconventional monetary policy. However, we show that the two policies are equivalent due to the endogeneity of hoarding. In contrast, targeted interventions such as discount-window lending can alleviate both inefficiencies at the same time.
American Economic Review (Papers and Proceedings), 2016, 106(5), 490–495.
with Todd Keister, James McAndrews and Tanju Yorulmazer
We use a simple analytical framework to illustrate the determinants of a financial intermediary’s ability to survive stress events. An intermediary in our framework faces two types of risk: the value of its assets may decline and/or its short-term creditors may decide not to roll over their debt. We measure its stability by looking at what combinations of shocks it can experience while remaining solvent. We study how stability depends on the intermediary’s balance-sheet characteristics such as its leverage, the maturity structure of its debt, and the liquidity and riskiness of its asset portfolio. We also show how our framework can be applied to study current policy issues, including liquidity requirements, discount window policy, and different approaches to reforming money market mutual funds.
Federal Reserve Bank of New York Economic Policy Review, 2014, 20(1), 29–49.
This article surveys the macroeconomic implications of financial frictions. Financial frictions lead to persistence and when combined with illiquidity to non-linear amplification effects. Risk is endogenous and liquidity spirals cause financial instability. Increasing margins further restrict leverage and exacerbate downturns. A demand for liquid assets and a role for money emerges. The market outcome is generically not even constrained efficient and the issuance of government debt can lead to a Pareto improvement. While financial institutions can mitigate frictions, they introduce additional fragility and through their erratic money creation harm price stability.
in Advances in Economics and Econometrics, Tenth World Congress of the Econometric Society, 2013, ed. by D. Acemoglu, M. Arellano and E. Dekel, Cambridge University Press.
We use high-frequency interbank payments data to trace deposit flows in March 2023 and identify twenty-two banks that suffered a run, significantly more than the two that failed but fewer than the number that experienced large negative stock returns. The runs were driven by a small number of large depositors and were related to weak fundamentals. However, we find evidence for the importance of coordination because run banks were disproportionately publicly traded and many banks with similarly bad fundamentals did not suffer a run. Banks survived the run by borrowing new funds and raising deposit rates, not by selling securities.
with Kenechukwu Anadu, Pablo Azar, Marco Cipriani, Catherine Huang, Mattia Landoni, Gabriele La Spada, Marco Macchiavelli, Antoine Malfroy-Camine and J. Christina Wang
Similar to the more traditional money market funds (MMFs), stablecoins aim to provide investors with safe, money-like assets. We investigate similarities and differences between these two investment products. Like MMFs, stablecoins suffer from “flight-to-safety” dynamics: we document net flows from riskier to safer stablecoins on days of crypto-market stress and estimate a discrete “break-the-buck” threshold of $1, below which stablecoin redemptions accelerate. We then focus on two specific stablecoin runs, in 2022 and 2023, showing that the same flight-to-safety dynamics also characterized these episodes. Finally, as flight-to-safety flows occur within MMF families, stablecoin flows tend to happen within blockchains.
In March 2020, safe asset markets experienced surprising and unprecedented price crashes. We explain how strategic investor behavior can create such market fragility in a model with investors valuing safety, investors valuing liquidity, and constrained dealers. While safety investors and liquidity investors can interact symbiotically with offsetting trades in times of stress, liquidity investors’ strategic interaction harbors the potential for self-fulfilling fragility. When the market is fragile, standard flight-to-safety can have a destabilizing effect and trigger a dash-for-cash by liquidity investors. Well-designed policy interventions can reduce market fragility ex ante and restore orderly functioning ex post.
Review of Financial Studies, revision requested.
Winner, Best Paper Award, 2022 Johns Hopkins Carey Finance Conference
with Nina Boyarchenko, Pooja Gupta, Or Shachar, and Peter Van Tassel
We argue that post-crisis banking regulations pass through from regulated institutions to unregulated arbitrageurs. We document that, once post-crisis regulations bind post 2014, hedge funds use a larger number of prime brokers, diversify away from G-SIB affiliated prime brokers, and that the match to such prime brokers is more fragile. Tighter regulatory constraints disincentivize regulated institutions not only to engage in arbitrage activity themselves but also to provide leverage to other arbitrageurs. Indeed, we show that the maximum leverage allowed and the implied return on basis trades is considerably lower under post-crisis regulation, in spite of persistently wider spreads.
with Marianne Andries, Jay Kahn, and Martin Schmalz
We empirically investigate the term structure of variance risk pricing and how it varies over time. We estimate the aversion to variance risk in a stochastic-volatility option pricing model separately for options of different maturities and find that variance risk pricing decreases in absolute value with maturity but remains significantly different from zero up to the nine-month horizon. We find consistent non-parametric results using estimates from Sharpe ratios of delta-neutral straddles. We further show that the term structure is downward sloping both during normal times and in times of stress, when required compensation for variance risk increases and its term structure steepens further.
We provide a model that can explain empirically relevant variations in confidence and risk taking by combining horizon-dependent risk aversion (“anxiety”) and selective memory in a Bayesian intra-personal game. In the time-series, overconfidence is more prevalent when actual risk levels are high, while underconfidence occurs when risks are low. In the cross-section, more anxious agents are more prone to biased confidence and their beliefs fluctuate more. This systematic variation in confidence levels can lead to objectively excessive risk taking by “insiders” with the potential to amplify boom-bust cycles.
with Kenechukwu Anadu, Pablo Azar, Marco Cipriani, Catherine Huang, Mattia Landoni, Gabriele La Spada, Marco Macchiavelli, Antoine Malfroy-Camine, and Christina Wang, FRBNY Liberty Street Economics Blog, March 8, 2024.
with Kenechukwu Anadu, Pablo Azar, Marco Cipriani, Catherine Huang, Mattia Landoni, Gabriele La Spada, Marco Macchiavelli, Antoine Malfroy-Camine, and Christina Wang, FRBNY Liberty Street Economics Blog, July 12, 2023.
with Kristian Blickle, Matteo Crosignani, Fernando Duarte, Fulvia Fringuellotti, and Anna Kovner, FRBNY Liberty Street Economics Blog, November 16, 2020.
with Nina Boyarchenko, Pooja Gupta, Or Shachar, and Peter Van Tassel, FRBNY Liberty Street Economics Blog, October 18, 2018. (Also published as Oxford Business Law Blog, October 18, 2018.)
with David Lucca and Karen Shen, FRBNY Liberty Street Economics Blog, October 31, 2012.
Presentations
“ca” indicates presentation by coauthor
2024:
Fed “Day Ahead” Conference on Financial Markets and Institutions; Boston/New York Fed Conference on the Financial Stability Implications of Stablecoins (ca); SFS Cavalcade; Bundesbank/Bank of Canada International Conference on Payments and Securities Settlement (ca); IMF-Wharton Conference on Financial and Real Implications of Technologies, AI, and Cyber Risk (ca); Yale Fighting a Financial Crisis Conference; European Central Bank; Humboldt University/Bundesbank Conference on Markets and Intermediaries; Boston Fed Stress Testing Conference (ca); Johns Hopkins Carey Finance Conference (ca); Wharton Conference on Liquidity and Financial Fragility; Atlanta Fed/GSU Conference on the Evolving Structure of the Financial Services Industry (scheduled).
2023:
IOSCO Financial Stability Engagement Group (ca); Economics of Payments XII Conference (ca); Boston Fed; ABS-Wharton Workshop on Safety vs. Liquidity Demand.
2022:
European Banking Center Conference; Columbia Cyber Risk to Financial Stability Workshop; The Economics of Payments Conference at the Bank of Canada (ca); Fed System Conference on Financial Institutions, Regulation, and Markets; Johns Hopkins Carey Finance Conference; Office of Financial Research; ECB Conference on Money Markets; Bank of Canada.
2021:
CEMFI.
2020:
Western Finance Association (ca); NBER Summer Institute (ca); Central Bank Research Association; Bank of Canada Annual Economic Conference (ca).
2019:
Econometric Society (ca); Swiss Winter Finance Conference (ca); Banco de España–CEMFI Conference on Financial Stability; Drexel University; European Finance Association (ca).
2018:
Western Finance Association (ca); Oxford Financial Intermediation Theory Conference (ca).
2017:
Jackson Hole Finance Conference; Adam Smith Workshop (ca); Banco de España–CEMFI Conference on Financial Stability (ca); Society for Economic Dynamics; Western Finance Association; Chicago-Minnesota Theory Conference; Workshop on Measurement and Control of Systemic Risks in the Financial Sector; University of Mannheim; Deutsche Bundesbank; Frankfurt School of Finance & Management; European Central Bank.
2016:
American Economic Association (ca); American Finance Association (ca); NY Fed Conference on Supervising Large & Complex Financial Institutions; Global Games Conference at Iowa State University; Rutgers University; Brandeis Summer Workshop; Research in Behavioral Finance Conference (self & ca); Wharton Conference on Liquidity and Financial Crises; International Banking Conference at Bocconi (ca); University of British Columbia.
2015:
European Winter Finance Conference (ca); University of Amsterdam; Financial Intermediation Research Society (ca); Mitsui Finance Symposium (self & ca); Society for Economic Dynamics (ca); Econometric Society (self & ca); European Economic Association (ca); European Finance Association (ca); Trinity of Stability Conference at Princeton; Cass Business School; German Economists Abroad Meeting.
2014:
European Winter Finance Conference; NYU Stern; ECB; University of Amsterdam; Hong Kong University of Science and Technology; Financial Intermediation Research Society; Western Finance Association; Society for Economic Dynamics; Isaac Newton Institute; NBER Asset Pricing Workshop (ca).
2013:
American Finance Association Meeting in San Diego (ca); Finance Down Under in Melbourne (ca); Macroeconomic Financial Modeling and Macroeconomic Fragility Conference in Cambridge, MA (ca).
2012:
People & Money Symposium at DePaul University; Academy of Behavioral Finance & Economics Meeting in New York.
2011:
Whitebox Doctoral Conference at Yale University (ca); Behavioral Finance Conference at the University of Miami.
2011:
EconCon at Princeton University.
Discussions
Livdan, Schürhoff, and Sokolov, “The Economic Impact of Payment System Stress: Evidence from Russia.” NBER Summer Institute, 2024.
Khetan, Li, Neamtu, and Sen, “The Market for Sharing Interest Rate Risk: Quantities and Asset Prices.” OFR Rising Scholars Conference, 2024.
Ahnert, Bertsch, Leonello, and Marquez, “Bank Fragility and the Incentive to Manage Risk.” Conference on Rethinking Optimal Deposit Insurance an Yale University, 2024.
Anbil, Anderson, Cohen, and Ruprecht, “Stop Believing in Reserves.” Fed System Conference on Financial Institutions, Regulation, and Markets, 2023.
Rosen and Zhong, “Securities Portfolio Management in the Banking Sector.” OCC Symposium on Emerging Risks in the Banking System, 2023.
Kotidis and Schreft, “Cyberattacks and Financial Stability: Evidence from a Natural Experiment.” Interagency Risk Quantification Forum, 2022.
Adelino, McCartney and Schoar, “The Role of Government and Private Institutions in Credit Cycles in the U.S. Mortgage Market.” American Finance Association, 2021.
Leonello, Mendicino, Panetti and Porcellacchia, “Savings, Efficiency and the Nature of Bank Runs.” Central Bank Research Association, 2020.
Glode, Opp, and Sverchkov, “To Pool or Not to Pool? Security Design in OTC Markets.” Oxford Financial Intermediation Theory Conference, 2019.
Infante and Vardoulakis, “Collateral Runs.” System Committee Meeting on on Financial Institutions, Regulations and Markets, Philadelphia Fed, 2018.
Coen, Lepore, and Schaaning, “Taking Regulation Seriously: Fire Sales under Solvency and Liquidity Constraints.” Stress Testing Research Conference, Boston Fed, 2018.
Malherbe and McMahon, “Financial Sector Origins of Economic Growth Delusions.” Oxford Financial Intermediation Theory Conference, 2017.
De Roure, “Fire Buys of Central Bank Collateral Assets.” Yale Program on Financial Stability, 2017.
Zeng, “A Dynamic Theory of Mutual Fund Runs and Liquidity Management.” Oxford Financial Intermediation Theory Conference, 2016.
Lorenzoni and Werning, “Slow Moving Debt Crises.” Global Games in Ames, 2016.
Silva, “Strategic Complementarity in Banks’ Funding Liquidity Choices and Financial Stability.” Network Models and Stress Testing for Financial Stability Monitoring and Macroprudential Policy Design and Implementation, Banco de Mexico, 2015.
Citci and Inci, “Career Concerns and Bayesian Overconfidence of Managers.” European Finance Association, Cambridge, 2013.
Bordalo, Gennaioli, and Shleifer, “Salience and Consumer Choice.” Econometric Society, San Diego, 2013.
Monnet and Sanches, “Private Money and Banking Regulation.” System Committee Meeting on Financial Structure and Regulation, Chicago Fed, 2012.
Abbassi and Fecht, “Liquidity of Financial Markets and the Demand for Reserves.” European Finance Association, Copenhagen, 2012.
Sun and Widdicks, “Why Do Employees Like to Be Paid with Options? A Multi-period Prospect Theory Approach.” European Finance Association, Copenhagen, 2012.
Martin and Taddei, “International Capital Flows and Credit Market Imperfections: A Tale of Two Frictions.” Mitsui Finance Symposium, Michigan Ross, 2012.
Professional Activities
Referee:
AEJ Macroeconomics; American Economic Review; Econometrica; Economics Letters; European Economic Review; International Economic Review; Journal of Economic Literature; Journal of Economic Dynamics and Control; Journal of Economic Theory; Journal of Finance; Journal of Financial Economics; Journal of Financial Intermediation; Journal of Mathematical Economics; Journal of Monetary Economics; Journal of Money, Credit, and Banking; Journal of Political Economy; Management Science; Review of Corporate Finance Studies; Review of Economic Studies; Review of Finance; Review of Financial Studies.
Program Committee Member:
Western Finance Association Annual Meeting, 2013–2019; European Finance Association Annual Meeting, 2015–2016, 2020–2024; Oxford Financial Intermediation Theory Conference (OxFIT), 2018–2024; OFR/RCFS Rising Scholars Conference, 2023–2025.
Co-Organizer:
New York Fed Money and Payments Workshop, 2012; New York Fed Workshop on the Risks of Wholesale Funding, 2014.