London School of Economics
- Informational Black Holes in Financial Markets (with U. Axelson)
We study how well primary financial markets allocate capital when information about investment opportunities is dispersed across market participants. Paradoxically, the fact that information is valuable for real investment decisions destroys the efficiency of the market. To add to the paradox, as the number of market participants with useful information increases a growing share of them fall into an "informational black hole," making markets even less efficient. Contrary to the predictions of standard theory, social surplus and the revenues of an entrepreneur seeking financing can be decreasing in the size of the market, and collusion among investors may enhance efficiency.
- Deliberate Limits to Arbitrage (with G. Plantin)
This paper develops a model in which arbitrageurs are collectively unconstrained, but may still prefer to incur individual limits to arbitrage rather than make full use of their combined resources. These deliberate limits arise because the communication of an arbitrage position reveals the underlying idea, which creates future competition in the absence of relevant property rights. We allow arbitrage opportunities to vary along two dimensions: the ease with which they can be identified and the speed at which they mature. We find that deliberate limits to arbitrage arise for opportunities in the mid-range of the maturity dimension. This range widens when the opportunities are easier to find. Our results thus offer a set of theoretical predictions about the arbitrage trades that are likely to exist in the market.
- Sources of Systematic Risk (with D. Papanikolau)
Using the restrictions implied by the heteroskedasticity of stock returns, we identify four factors in the U.S. industry returns. The first correlates highly with the market portfolio; the second is a portfolio of stocks that produce investment goods minus stocks that produce consumption goods; the third differentiates between cyclical and noncyclical stocks. The fourth, a portfolio of industries that produce input goods minus the rest of the market, is a robust predictor of excess returns on the market portfolio and bond returns. The extracted factors are shown to contain significant information about future macroeconomic and financial variables.
- Sequential Credit Markets (with U. Axelson)
Entrepreneurs who seek financing for projects typically do so in decentralized markets where they need to approach investors sequentially. We study how well such sequential markets allocate resources when investors have expertise in evaluating investment opportunities, and how surplus is split between entrepreneurs and financiers. Contrary to common belief, we show that the introduction of a credit registry that tracks the application history of a borrower leads to more adverse selection, quicker market break down, and higher rents to investors which are not competed away even as the number of investors grows large. Although sequential search markets lead to substantial investment inefficiencies, they can nevertheless be more efficient than a centralized exchange where excessive competition may impede information aggregation. We also show that investors who rely purely on public information in their lending decisions can out-compete better informed investors with soft information, and that an introduction of interest rate caps can increase the efficiency of the market.
- Outsized Arbitrage
This paper studies incentives and trading decisions of arbitrageurs who take concentrated bets in markets with price impact. Price impact and the practice of marking-to-market funds' assets allow arbitrageurs to show good interim performance even when fundamentals move against them but can also trap them in outsized arbitrage. Every time a manager attempts to inflate the marked-to-market value of his arbitrage position he scales up his position. The larger grows his position, the more the manager gets exposed to its value, which puts him in a vicious cycle of building an excessive arbitrage position by constantly trying to support it. The paper shows that outsized arbitrage can result in large losses to investors, persistent mispricing in the market, and negative skewness in returns.
- Rewarding Trading Skills Without Inducing Gambling
(with G. Plantin), Journal of Finance, 70, (2015).
- CDS Auctions
(with M. Chernov and A. Gorbenko), Review of Financial Studies 26, (2013).
- Equilibrium Subprime Lending
(with G. Plantin), Journal of Finance, 68, (2013).
- Forecasting the Forecasts of Others: Implications for Asset Pricing
(with O. Rytchkov), Journal of Economic Theory 147, (2012).
- The Equity Risk Premium and the Risk-free Rate in an Economy with Borrowing Constraints
(with L. Kogan and R. Uppal), Mathematics and Financial Economics 1, (2007). Lead article, inaugural issue.
- An Econometric Analysis of Serial Correlation and Illiquidity in Hedge-Fund Returns
(with M. Getmansky and A. Lo), Journal of Financial Economics 74, (2004).
- Debt Overhang and Barter in Russia
(with S. Guriev and M. Maurel), Journal of Comparative Economics, (2002).