Paolo Colla

Which Financial Frictions? Parsing the Evidence from the Financial Crisis of 2007-9

The nancial crisis of 2007-9 has sparked keen interest in models of nancial frictions and their impact on macro activity. Most models share the feature that borrowers su er a contraction in the quantity of credit. However, the evidence suggests that although bank lending to rms declines during the crisis, bond nancing actually increases to make up much of the gap. This paper reviews both aggregate and micro level data and highlights the shift in the composition of credit between loans and bonds. Motivated by the evidence, we formulate a model of direct and intermediated credit that captures the key stylized facts. In our model, the impact on real activity comes from the spike in risk premiums, rather than contraction in the total quantity of credit. Paper prepared for the NBER Macro Annual Conference, April 20-21, 2012. We thank Daron Acemoglu, Olivier Blanchard, Thomas Eisenbach, Simon Gilchrist, Arvind Krishnamurthy, Jonathan Parker and Michael Woodford for comments on an earlier version of the paper. We also thank Michael Roberts and Simon Gilchrist for making available data used in this paper.

Sovereign and Corporate Credit Risk: Evidence from the Eurozone

We study the impact of sovereign risk on the credit risk of the non-financial corporate sector in the Eurozone using credit default swap data. We show that an increase in sovereign risk is associated with a statistically and economically significant increase in corporate credit risk and, hence, firms’ borrowing costs. A deterioration in a country’s credit quality affects more adversely firms that are more likely to benefit from government aid, those whose sales are more concentrated in the domestic market, and those that rely more heavily on bank financing. Our findings suggest that government guarantees, domestic demand, and credit markets are important credit risk transmission mechanisms.

Environmental Policy and Speculation on Markets for Emission Permits

Tradable emission permits share many characteristics with financial assets. As on financial markets, speculators are likely to be active on large markets for emission permits such as those developing under the Kyoto Protocol. We show how the presence of speculators on a market for emission permits affects the price of these permits when firms face risk aversion. The agency in charge of the optimal environmental policy should account for the presence of speculators when determining the total amount of permits to issue.

A portfolio-based evaluation of affine term structure models

We focus on affine term structure models as tools for active bond portfolio management. Our financial exercise comprises the following steps: 1) forecast the future values of the state variables implied by several multi-factor models; 2) approximate the conditional moments of the state vector to come up with discrete scenarios for the future state variables 3) compute bond returns for various maturities at future dates from the theoretical asset pricing relations 4) solve the portfolio problem faced by an investor with a six month horizon who takes into account the possibility to rebalance after one quarter. The sequence of optimal portfolios is evaluated in terms of financial properties. We show that a financial based evaluation of term structure models may yield results conflicting with those obtained from a statistical evaluation.

Does Expected Supply Affect the Price of Emission Permits? Evidence from Phase I in the European System

Does current and future supply affect the market price of pemits? The answer should be positive as the market itself was created by the governments that also control the supply. However, governments themselves may be uncertain about the relation between supply and price and may go through a learning period. Do investors believe in the announcements of governments about the future supply? We find the answer was positive at least regarding Phase I of the European system, where empirical evidence about a current excess supply of permits was offset by announcements of a future excess demand.

Board Connections and Debt Structure in Family Firms

We investigate the effect of board interlocks on family firms’ debt structure. Using a comprehensive panel data set from Italy, our empirical evidence indicates that interlocked directors facilitate family firms’ access to external debt, mostly in the form of trade debt. During episodes of liquidity dry-ups, board interlocks prove useful to withstand funding shortages and, in turn, to cope with the negative effects of the recession. These findings are consistent with the view that interlocked directors act as information and resource providers along the supply chain.

The Price of Law: The Case of the Eurozone Collective Action Clauses

Do markets value contract protections and does the quality of a legal system affect such valuations? We answer these questions by analysing a quasi-natural experiment whereby after January 1, 2013, newly issued sovereign bonds of all Eurozone countries started to include Collective Action Clauses (CACs) specifying the minimum vote needed to modify repayment. We find that the new contract term is priced, i.e., CAC bonds trade at lower yields relative to otherwise similar bonds that do not include CACs, and also that the quality of the legal system matters for this differential: The better the legal system, the lower the yield.

Syndication and Second Loan Sales

Secondary loan sales give originating banks the opportunity to diversify part of their credit risk by selling loans to other market participants. However, as originating banks are less exposed to risk after secondary loan sales, their incentives to monitor borrowers diminish. Secondary loan sales therefore involve a trade-off between diversification benefits and sub-optimal monitoring. We explore this trade-off within a theoretical model. The results show that in equilibrium loans trade at a discount because monitoring effort is sub-optimally low. We illustrate how this inefficiency is related to lack of transparency in the secondary loan market, and provide policy implications to address this problem.