Kathy Yuan

Network Risk and Key Players: A Structural Analysis of Interbank Liquidity

We model banks’ liquidity holding decision as a simultaneous game on an interbank borrowing network. We show that at the Nash equilibrium, the contributions of each bank to the network liquidity level and liquidity risk are distinct functions of its indegree and outdegree Katz-Bonacich centrality measures. A wedge between the planner and the market equilibria arises because individual banks do not internalize the effect of their liquidity choice on other banks’ liquidity benefit and risk exposure. The network can act as an absorbent or a multiplier of individual banks’ shocks. Using a sterling interbank network database from January 2006 to September 2010, we estimate the model in a spatial error framework, and find evidence for a substantial, and time varying, network risk: in the period before the Lehman crisis, the network is cohesive and liquidity holding decisions are complementary and there is a large network liquidity multiplier; during the 2007-08 crisis, the network becomes less clustered and liquidity holding less dependent on the network; after the crisis, during Quantitative Easing, the network liquidity multiplier becomes negative, implying a lower network potential for generating liquidity. The network impulse-response functions indicate that the risk key players during these periods vary, and are not necessarily the largest borrowers.

Within-Bank Spillovers of Real Estate Shocks

By considering banks as portfolios of assets in different locations, we study the transmission of negative real estate shocks across bank’s business areas and geographical locations while controlling for local demand shocks and bank location–specific factors. Affected banks recognize capital losses and cut lending across the board indicating contagion across business lines and locations. They also roll over and fail to liquidate problematic loans, in addition to reducing their operational costs and depleting their liquidity. These results provide evidence of bank balance sheet transmission and amplification of real estate shocks.

On the Growth Effect of Liberalizations

Using panel data on industries in emerging markets, we investigate the effect of stock market liberalizations on industrial growth. Our paper makes the following methodological contributions: First, we address the potential endogeneity of stock market liberalization using fixed effects, instrumental variable, and dynamic generalized method of moment specifications. Second, we contruct new measures to distinguish between the external dependence and growth opportunities hypotheses about the mechanism by which liberalization is likely to affect growth. Third, to isolate the impact of liberalization we collect new data to control for contemporaneous economic reforms, including privatization, macroeconomic stabilization, and trade liberalization. Result from the fixed-effects specifications suggest that both industries that are technologically more dependent on external sources of finance, and industries that face better growth opportunities, grow significantly faster following liberalization. However, when liberalization is treated as endogenous then growth opportunities no longer have a significant impact on industrial growth. This suggests that countries may time liberalizations to coincide with better industry growth opportunities.

Stock Market Tournament

We study an optimal contracting problem between shareholders and managers when managers’ effort choices are hidden but on which stock market prices reveal some information. When the stock market rewards winners and punishes losers within an industry, stock-based incentive generates a tournament effect and causes strategic complementarity among managers of different firms in exerting effort. In the presence of this complementarity in managerial efforts, shareholders fail to internalize the impact of incentive provision to their own manager on the average industry effort level. They over (under) incentivise managers, leading managers to exert too much (little) effort, exposing shareholders to excessive (insufficient) systematic risk relative to the second best (and even the first best) during the boom (bust).