Research
Corporate-Sovereign Debt Nexus and Externalities (Job Market Paper) [PDF]
covered by ECB Speech (Jan 28, 2021)
I show that corporate debt accumulation during booms can explain increases in sovereign risk during stress periods. Using idiosyncratic shocks to large firms as instruments for aggregate corporate leverage, I show that rising corporate leverage during the period 2002-2007 causally increases sovereign spreads in six Eurozone countries during the debt crisis period of 2008-2012. To explain these findings, I build a dynamic quantitative model in which both firms and the government can default. Rising corporate debt increases sovereign default risk, as tax revenues are expected to decrease. Externalities arise because it can be privately optimal but socially suboptimal for firms to default given their limited liability. The fact that firms do not take into account the effect of their debt accumulation on aggregate sovereign spreads is an important externality, rationalizing macroprudential interventions in corporate debt markets. I propose a set of such optimal debt policies that reduce the number of defaulting firms, increase fiscal space, and boost household consumption during financial crises. Both constant and countercyclical debt tax schedules can correct overborrowing externalities. Contrary to conventional wisdom, countercyclical debt policy is less effective than constant debt policy, as the countercyclical policy induces more firm defaults.
Capital Flows and Leverage [Journal Link]
with Şebnem Kalemli-Özcan, Annual Review of Economics, Vol.12, 833-846, August 2020
This article surveys the literature on capital flows and leverage. We summarize results from the existing papers and document new facts. The empirical literature takes both a macro and a micro approach. The macro approach focuses on aggregate data both over time and in the cross-section of countries, and it documents a positive correlation between total capital flows, build-ups in terms of external and domestic debt to GDP ratio, and financial crises. The micro approach uses granular data and focuses on leverage at the firm and bank level and associates this leverage with country-level capital flows and related exchange rate movements. We document new facts from a hybrid approach that focuses on the relationship between sector-level capital flows and sectoral leverage. We highlight the interconnections between different approaches and argue that harmonization of the macro and micro approaches can yield a more complete understanding of the effect of capital flows on country-, sector-, and firm- and bank-level leverage associated with credit booms and busts.
Does Trade Cause Capital to Flow? Evidence from Historical Rainfall [PDF] [Journal Link]
with Şebnem Kalemli-Özcan and Alex Nikolsko-Rzevhskyy, Journal of Development Economics, Vol.147, 102537, November 2020
We use a historical quasi-experiment to estimate the causal effect of trade on capital flows. We argue that fluctuations in regional rainfall within the Ottoman Empire capture the exogenous variation in exports from the Empire to Germany, France, and the U.K., during the period of 1859–1913. The identification is based on the following historical facts: First, only surplus production was allowed to be exported from the Empire (provisionistic policy). Second, different products grown in different regions were subject to variation in regional rainfall. Third, different bundles of products were exported to Germany, France, and the U.K. by the Empire. Using the export-bundle-weighted regional rainfall as an instrument for Ottoman exports to each country, our instrumental variable regression suggests the following: When a given region of the Empire received more rainfall than others, the resulting surplus production was exported more to countries that historically imported more of those products, and this leads to higher foreign investment by those countries in the Empire. Our findings support theories predicting complementarity between trade and finance, in which causality runs from trade to capital flows.
Global Financial Cycles and Inequality in Emerging Economies
with Donggyu Lee, work in progress
We investigate an optimal mix of exchange rate management and macroprudential policies and its consequences for inequality and welfare in emerging market economies. We build an open economy New Keynesian model with heterogeneous households in which domestic banks hold foreign currency debt. Floating exchange rates and associated risk of depreciation make banks less likely to issue debt abroad and thus less likely to grant loans to firms, resulting in drops in equity prices and welfare losses of the rich. However, floating exchange rates can achieve full employment, which mainly benefits the poor. We hypothesize that a more flexible exchange rate management policy can reduce inequality but have ambiguous effects on total welfare. The combination of flexible exchange rates and regulations on domestic banks’ foreign currency debt can reduce inequality and increase total welfare.