Ariel Zetlin-Jones

Current Research

JOB MARKET PAPER

External Financing and the Role of Financial Frictions over the Business Cycle: Measurement and Theory, with Ali Shourideh [PDF, 16 January 2012]

We examine the quantitative importance of financial market shocks in accounting for business cycle fluctuations. We emphasize the role financial markets play in reallocating funds from cash-rich, low productivity firms to cash-poor, high productivity firms. We use evidence on financial flows to analyze the importance of this role of financial markets. This evidence shows that in the aggregate, funds available to firms internally are more than adequate to finance investment. At the firm level, we find that for publicly traded firms (in Compustat), almost all investment is financed internally while, using an alternative data source (Amadeus), we find that most investment by privately held firms is financed through borrowing. These observations suggest that the quantitative impact of financial market shocks depend both on the sensitivity of investment and output of privately held firms to such shocks and on the extent to which the investment and output of publicly held firms respond to the actions of privately held firms. Motivated by these observations, we build a quantitative model featuring publicly and privately held firms that face collateral constraints and idiosyncratic risk over productivity. We model financial market shocks as shocks to the collateral constraints. In our model, each firm has a monopoly in producing a differentiated good and uses the goods produced by other firms as an input in production -- features that create non-financial linkages between publicly and privately held firms. In our calibrated model, we find that a shock to the collateral constraints which generates a one standard deviation decline in the debt-to-asset ratio leads to a 0.5% decline in aggregate output on impact, roughly comparable to the effect of a one standard deviation shock to aggregate productivity in a standard real business cycle model. In this sense, we find that disturbances in financial markets are a promising source of business cycle fluctuations when non-financial linkages across firms are sufficiently strong.

WORKING PAPERS

Efficient Financial Crises (coming soon!)

This paper analyzes the causes of financial crises and the consequences of policies designed to mitigate their effects. I provide new evidence that financial businesses use significantly more short term debt to finance their assets than do nonfinancial businesses. I develop a theory in which such differences in debt structure arise from the differences in information that investors have about the assets of financial and non-financial businesses. I show that differences in debt structure are socially optimal even though they lead to financial crises and that in my theory government interventions during a crisis, such as bailouts, are not desirable.

Adverse Selection, Reputation and Sudden Collapses in Secondary Loan Markets, with V.V. Chari and Ali Shourideh [PDF, 10 May 2011]

Loan originators often securitize some loans in secondary loan markets and hold on to others. New issuances in such secondary markets collapse abruptly on occasion, typically when collateral values used to secure the underlying loans fall and these collapses are viewed by policymakers as inefficient. We develop a dynamic adverse selection model in which small reductions in collateral values can generate abrupt inefficient collapses in new issuances in the secondary loan market by affecting reputational incentives. We find that a variety of policies intended to remedy market inefficiencies do not help resolve the adverse selection problem.

Moral Hazard, Reputation and Fragility in Credit Markets, with V.V. Chari and Ali Shourideh [under revision]

We analyze the extent to which reputational concerns may overcome moral hazard problems in credit markets. In such markets, debt contracts are common, and with loan contracts, borrowers have incentives to take on high levels of risk if lenders cannot observe the types of projects in which borrowers invest funds. If borrowers intend to access credit markets repeatedly, they have incentives to acquire reputations for taking on low levels of risk. We argue that in such repeated moral hazard environments, reputational incentives are fragile. We show that such environments are plagued by dynamic coordination problems, in the sense that sustaining reputational incentives requires lenders in different periods of time to coordinate their actions. We show that a natural way of solving these coordination problems leads to a fragile equilibrium in which small changes in fundamentals results in large fluctuations in lending activity.