Andrea L. Eisfeldt

Aggregate Issuance and Savings Waves

We document the fact that at both the aggregate and the firm level, corporations tend to simultaneously raise external finance and accumulate liquid assets. For all but the very largest firms, the aggregate correlation between external finance raised and liquidity accumulation is 0.6, and the average firm level correlation is 0.2. This seems puzzling if internal and external finance are substitutes and external finance is costly. In fact, static pecking order intuition predicts that firms will first draw down liquid balances and only then issue external finance. On the other hand, if one believes that the cost of external finance varies over time, then the fact that there appear to be aggregate waves of issuance and savings activity may not be surprising. We show that a simple dynamic model with constant costs of external finance can easily match the observed positive correlation between liquidity accumulation and external finance. We compare the results of this simple model to those from a model which features a shock to the cost of external finance.

Smoothing with liquid and illiquid assets

A quantitative examination of the demand for liquid assets arising from consumption smoothing motives reveals that such demand is very low. Consumers faced with income streams calibrated to match income and unemployment data and returns and transactions costs calibrated to match US Treasury Bill data almost exclusively buy and hold illiquid long term assets even though the return premium on long term assets is quite small. This is because, with standard preferences, savings are highly persistent even when risky income is not. In the calibrated model, the first order autocorrelation of savings is an order of magnitude larger than that of income.

Prepayment Risk and Expected MBS Returns

We present a simple, linear asset pricing model of the cross section of Mortgage-Backed Security (MBS) returns. We measure prepayment risk and estimate security risk loadings using real data on prepayment forecasts vs. realizations. Estimated loadings are monotonic in securities’ coupons relative to the par coupon, as predicted by the model. Prepayment risks appear to be priced by specialized MBS investors. In particular, we find convincing evidence that prepayment risk prices change sign over time with the sign of a representative MBS investor’s exposure to prepayment risk.

Complex Asset Markets

We develop a dynamic equilibrium model of complex asset markets with endogenous entry and exit in which the investment technology of investors with more expertise is subject to less asset-specific risk. The joint equilibrium distribution of financial expertise and wealth then determines risk bearing capacity. Higher expert demand lowers equilibrium required returns, reducing overall participation. In equilibrium, investor participation in more complex asset markets with more asset-specific risk is lower, despite higher market- level Sharpe ratios, provided that asset complexity and expertise are complementary. We analyze how asset complexity affects the stationary wealth distribution of complex asset investors. Because of selection, increased asset complexity reduces wealth concentration, even though the wealth distribution for more expert investors has fatter tails.