Gustavo A. Suarez

Bootstrap and Higher-Order Expansion Validity When Instruments May Be Weak

It is well-known that size-adjustments based on Edgeworth expansions for the t-statistic perform poorly when instruments are weakly correlated with the endogenous explanatory variable. This paper shows, however, that the lack of Edgeworth expansions and bootstrap validity are not tied to the weak instrument framework, but instead depends on which test statistic is examined. In particular, Edgeworth expansions are valid for the score and conditional likelihood ratio approaches, even when the instruments are uncorrelated with the endogenous explanatory variable. Furthermore, there is a belief that the bootstrap method fails when instruments are weak, since it replaces parameters with inconsistent estimators. Contrary to this notion, we provide a theoretical proof that guarantees the validity of the bootstrap for the score test, as well as the validity of the conditional bootstrap for many conditional tests. Monte Carlo simulations show that the bootstrap actually decreases size distortions in both cases.

The Financial Sector and the Real Economy During the Financial Crisis: Evidence from the Commercial Paper Market

Shocks to the financial sector led credit spreads to widen to unprecedented levels in many markets during the 2007-2008 financial crisis. The rise in spreads attracted attention because it could signal a disruption in financial markets, which has been widely linked to an increased burden on non-financial firms. This paper disentangles the relative contributions of credit and liquidity risk in explaining the widening of commercial paper spreads. In doing so, we find that liquidity risk was isolated to the financial sector throughout the first two major shocks to the system (August 2007 and March 2008). Indeed, controlling for credit risk, non-financial corporations saw little or no change in the cost of funding during this time period. After the bankruptcy of Lehman Brothers, for the first time, liquidity problems in the commercial paper market spilled out of the financial sector into the spreads of low credit quality non-financial firms. This effect had a disproportionately larger impact on those low credit-quality non-financial firms that placed paper exclusively through financial sector dealers. High credit quality firms remained unaffected throughout. Our interpretation of the results is that markets were able to differentiate not only between safe and imperiled firms in the midst of the crisis, but also to isolate where liquidity effects were most likely to be salient.

Exploring the Racial Wealth Gap Using the Survey of Consumer Finances

This paper studies the racial wealth gap using data from the Federal Reserve’s Survey of Consumer Finances from 1989 to 2013. We document that the mean and median wealth (net worth) of white families has consistently been much greater than that of black and Hispanic families, and the gap between them has increased in recent years. We use reduced-form OLS regressions and non-parametric decomposition techniques to assess the contribution to the racial wealth gap of life-cycle patterns, educational attainment, inheritance, attitudes toward saving and investing, and a number of additional factors. Our analysis indicates that the wealth gap between white and Hispanic families can be almost entirely attributed to differences in observable variables. Observable factors account for most of the gap between white and black families, but a substantial unexplained portion remains. Wealth differences between black and white families are completely due to different asset holdings, while wealth differences between black and Hispanic families are mostly a result of different debt holdings. The unexplained portion of the wealth gap, for white families relative to black and Hispanic families, is greater at the top of the wealth distribution.

Bank Leverage and Monetary Policy's Risk-Taking Channel

We present evidence of a risk-taking channel of monetary policy for the U.S. banking system. We use confidential data on the internal ratings of U.S. banks on loans to businesses over the period 1997 to 2011 from the Federal Reserve’s survey of terms of business lending. We find that ex-ante risk taking by banks (as measured by the risk rating of the bank’s new loans) is negatively associated with increases in short-term policy interest rates. This relationship is more pronounced in regions that are less in sync with the nationwide business cycle, and less pronounced for banks with relatively low capital or during periods when banks’ capital erodes, such as episodes of financial and economic distress. These results contribute to the ongoing debate on the role of monetary policy in financial stability and suggest that monetary policy has a bearing on the riskiness of banks and financial stability more generally. JEL classifications: E43, E52, G21

Why Isn't Investment More Sensitive to Interest Rates: Evidence from Surveys

A fundamental tenet of traditional theories of investment and monetary policy transmission is that interest rates are a critical determinant of business investment expenditures. Yet, a large body of empirical research offers mixed evidence, at best, for substantial interest-rate effects on investment. We examine the sensitivity of investment plans to interest rates based on surveys of CFOs during the recent economic recovery. We find that most firms claim their investment plans to be quite insensitive to decreases in interest rates, and only somewhat more responsive to interest rate increases. CFOs most frequently cited either ample cash or the low level of interest rates as reasons for lack of sensitivity. In the cross-section, we find that insensitivity to interest rate changes tends to be most pronounced among firms that do not indicate financial constraints as a top concern and firms with no near-term plans to borrow. Perhaps more surprisingly, investment is also less interest-rate sensitive at firms expecting higher year-ahead growth. These findings appear to be consistent with survey data on the “hurdle rates” firms report using to make new investments decisions: the average reported hurdle rate has hovered near 15 percent for decades, despite the downward trend in market interest rates. Moreover, firms expecting to grow more tend to have higher hurdle rates, suggesting a possible connection between interest rate insensitivity and high hurdle rates.

Do CFOs Think Investment is Sensitive to Interest Rules

This piece presents results from ongoing research that takes a new look at the sensitivity of a businesss capital expenditures to changes in interest rates.