Essays in macro-finance

Defence date: 19 June 2017Examining Board: Prof. David K. Levine, EUI, (Supervisor); Prof. Ramon Marimon, EUI; Prof. Hugo Hopenhayn, UCLA; Prof. Facundo Piguillem, Einaudi Institute for Economics and FinanceThis thesis deals with the economics of crises, within the macro-finance literature. The first chapter, coauthored with Rasmus Pank, deals with how crises emerge. Particularly, we are interested in how confidence affects the outcomes in an experimental asset market where the fundamental value is known by all the participants. We elicit expectations in a way that allows us to measure confidence. We ask participants to forecast the one-period-ahead price as a discrete probability mass distribution and find that confidence not only affects the price-formation in markets, but also is important in explaining the dynamics of the bubble. Moreover, as traders' confidence grows, they become increasingly more optimistic, thus increasing the likelihood of price bubbles. The remaining chapters deal with policy responses to crises. The second chapter, Banks vs Zombies, studies how zombie firms arise in equilibrium and the scope for policy. Zombie firms are otherwise insolvent borrowers who are kept afloat by new credit from banks to cover their losses. The practice, known as evergreening or zombie lending, has occurred in times of financial distress even when debt restructuring is allowed. I study the incentives to restructure debt in a borrower-lender game and provide conditions under which it is optimal to engage in evergreening even when socially inefficient. In normal times, the borrower can access a competitive credit market and pay the opportunity cost of capital. When a shock renders the creditor insolvent, debt needs to be restructured. The firm is locked in a lending relationship and the incumbent bank has monopoly power. Normally, a lender would liquidate the firm. However, the lender is also financially distressed, the incentives to restructure change radically. To keep the firm afloat and prevent its own bankruptcy, the bank covers the firms losses. It does not, however, fund investment, as the distressed borrower may not use the funds efficiently. Evergreening can happen for profitable investments and renegotiation does not solve the problem. I discuss policy alternatives and show that debt haircuts and bank capitalizations must be used simultaneously; and that monetary policy can behave differently in the presence of zombie firms. Finally, I provide evidence supporting the model using a novel panel data set of matched firms and banks for the case of Spain. The final chapter, Optimal Haircuts, analyzes the desirability of intervention in a simple model of heterogeneous firms and households. Households finance firm's working capital, and the credit constrained firms are heterogeneous in their productivity and hence debt levels. After an unexpected aggregate shock, less productive firms go bankrupt. This directly decreases the wage income of the households, and indirectly decreases their income from the defaulted loans to firms. The main result of the paper is that there is an optimal haircut for deposits such that both firms and families are better off. Moreover, there is a tension between maximizing welfare and maximizing output. This provides a rationale for the Cypriot, Hungarian and Argentinean experience. The model is adapted to an open economy and used to analyze a devaluation shock, which provides policy for countries attempting to escape a monetary union or a currency peg.-- 1 Certainty and decision-making in experimental asset markets -- 2 Banks vs zombies -- 3 Optimal haircut