Forthcoming in Economics Letters: “Narrative Fragmentation and the Business Cycle”

“Narrative Fragmentation and the Business Cycle” with Isaiah Hull and Xin Zhang (Sveriges Riksbank Working Paper No. 401; This version: 01/2021)

  • Abstract: According to Shiller (2017), economic and financial narratives often emerge as a con- sequence of their virality, rather than their veracity, and constitute an important, but understudied driver of aggregate fluctuations. Using a unique dataset of news- paper articles over the 1950-2019 period and state-of-the-art methods from natural language processing, we characterize the properties of business cycle narratives. Our main finding is that narratives tend to consolidate around a dominant explanation during expansions and fragment into competing explanations during contractions. We also show that the existence of past reference events is strongly associated with increased narrative consolidation. (C63, D84, E32, E7)
The figure above shows the rolling mean of detrended GDP growth plotted against detrended, within-topic entropy, averaged over all topics for the sample period 1965-2019.
  • Keywords: Natural Language Processing, Machine Learning, Narrative Economics.

New BIS Working Paper No. 923 “Optimal Bank Leverage and Recapitalization in Crowded Markets”

“Optimal Bank Leverage and Recapitalization in Crowded Markets” with Mike Mariathasan (BIS Working Paper No. 923, January 2021; Builds on older paper “Fire Sale Bank Recapitalizations”: 09/2015)

  • Abstract: We study optimal bank leverage and recapitalization in general equilibrium when the supply of specialized investment capital is imperfectly elastic. Assuming incomplete insurance against capital shortfalls and segmented financial markets, ex-ante leverage is inefficiently high, leading to excessive insolvencies during systemic capital shortfall events. Recapitalizations by equity issuance are individually and socially optimal. Additional frictions can turn asset sales individually but not necessarily socially optimal. Our results hold for different bankruptcy protocols and we offer testable predictions for banks’ capital structure management. Our model provides a rationale for macroprudential capital regulation that does not require moral hazard or informational asymmetries. (D5, D6, G21, G28)
This figure depicts for a given level of leverage (horizontal axis) the market-clearing price for specialized investment capital and the threshold level of bank portfolio risk below which liability side recapitalizations (red) and asset side recapitalizations (blue) are feasible.
  • Keywords: bank capital, recapitalization, macroprudential regulation, incomplete markets, financial market segmentation, constrained inefficiency.
  • Also available as Riksbank Working Paper No. 312

Forthcoming in the Journal of Banking and Finance: “Bank Misconduct and Online Lending”

“Bank Misconduct and Online Lending” with Isaiah Hull, Yingjie Qi and Xin Zhang, Journal of Banking and Finance (forthcoming)

  • Abstract: We introduce a high quality proxy for bank misconduct that is constructed from Consumer Financial Protection Bureau (CFPB) complaint data. We employ this proxy to measure the impact of bank misconduct on the expansion of online lending in the United States. Using nearly complete loan and application data from the online lending market, we demonstrate that bank misconduct is associated with a statistically and economically significant increase in online lending demand at the state and county levels. This result is robust to the inclusion of bank credit supply shocks and holds for both broader and more narrowly-defined bank misconduct measures. Furthermore, we show that this effect is strongest for lower rated borrowers and weakest in states with high levels of generalized trust. (A13, G00, G21, K00)
The figure shows the estimated difference in the P2P’s share of total debt between treated and control counties. The horizontal axis shows the number of months that have elapsed since a major banking scandal occurred in the treatment counties. The vertical axis shows the difference in the P2P’s share of total debt. We identify the date of bank scandals through the use of newspaper articles drawn from Factiva and CFPB enforcement actions. These events are also associated with sharp increases in the number of reported CFPB complaints.
  • Keywords: financial development, consumer loans, bank misconduct, FinTech.

New Riksbank Working Paper version of “A wake-up call theory of contagion”

“A wake-up call theory or contagion” with Toni Ahnert (This version: 03/2020; First version: 06/2012)

  • Abstract: We offer a theory of contagion based on the information choice of investors after observing a financial crisis elsewhere. We study global coordination games of regime change in two regions with an unobserved common macro shock as the only link between regions. A crisis in the first region is a wake-up call to investors in the second region. It induces them to reassess the regional fundamental and acquire information about the macro shock. Contagion can occur even after investors learn that regions are unrelated (zero macro shock). Our results rationalize empirical evidence about contagious bank runs and currency crises after wake-up calls. We also derive other testable implications of the model. (D83, F3, G01, G21)
The value of information v and the proportion of informed investors n2 with and without a wake-up call, f ∈ {1, 0}. The figure shows (1) the strategic complementarity in information choices and (2) the effect of a higher level of s that increases the skewness of the macro shock and leads to an expansion of the intermediate range of information costs for which we establish the wake-up call contagion effect.

Forthcoming in the Journal of International Money and Finance: “Spread the Word: International Spillovers from Central Bank Communication”

“Spread the Word: International Spillovers from Central Bank Communication” with Hanna Armelius, Isaiah Hull and Xin Zhang, Journal of International Money and Finance, Volume 103, Pages 1-32, May 2020. – Lead article –

    • Abstract: We construct a novel text dataset to measure the sentiment component of communications for 23 central banks over the 2002-2017 period. Our analysis yields three results. First, comovement in sentiment across central banks is not reducible to trade or financial flow exposures. Second, sentiment shocks generate cross-country spillovers in sentiment, policy rates, and macroeconomic variables; and the Fed appears to be a uniquely influential generator of such spillovers, even among prominent central banks. And third, geographic distance is a robust and economically significant determinant of comovement in central bank sentiment, while shared language and colonial ties have weaker predictive power. (JEL E52, E58, F42)

The figure show the normalized rolling net sentiment scores associated with ECB speeches. Sentiment scores are computed using a dictionary-based approach documented in Loughran and McDonald (2011).

New version of “Bank Misconduct and Online Lending”

“Bank Misconduct and Online Lending” with Isaiah Hull (Sveriges Riksbank), Yingjie Qi (Stockholm School of Economics) and Xin Zhang (Sveriges Riksbank)

  • Abstract:

We introduce a high quality proxy for bank misconduct that is constructed from
Consumer Financial Protection (CFPB) complaint data. We employ this proxy to
measure the impact of bank misconduct on the expansion of online lending in the
United States. Using nearly complete loan and application data from the online lending
market, we demonstrate that bank misconduct is associated with a statistically and
economically signi cant increase in online lending demand at the state and county
levels. This result is robust to the inclusion of bank credit supply shocks and holds for
both broader and more narrowly-de ned bank misconduct measures. Furthermore, we
show that this e ect is strongest for lower rated borrowers and weakest in states with
high levels of generalized trust.

  • Keywords: financial development, consumer loans, bank misconduct, FinTech.

New version of “Spread the Word: International Spillovers from Central Bank Communication”

“Spread the Word: International Spillovers from Central Bank Communication” with Hanna Armelius, Isaiah Hull and Xin Zhang (all at Sveriges Riksbank)
(This version: 05/2019; First version: 09/2018; Sveriges Riksbank Working Paper No. 357)

  • Abstract:

We construct a novel text dataset to measure the sentiment component of communications for 23 central banks over the 2002-2017 period. Our analysis yields three results. First, comovement in sentiment across central banks is not reducible to trade or financial flow exposures. Second, sentiment shocks generate cross-country spillovers in sentiment, policy rates, and macroeconomic variables; and the Fed appears to be a uniquely influential generator of such spillovers, even among prominent central banks. And third, geographic distance is a robust and economically significant determinant of comovement in central bank sentiment, while shared language and colonial ties have weaker predictive power. (JEL E52, E58, F42)

  • Keywords: communication, monetary policy, international policy transmission.

New working paper on “International Spillovers from Central Bank Communication”

“Spread the Word: International Spillovers from Central Bank Communication” with Hanna Armelius, Isaiah Hull and Xin Zhang (all at Sveriges Riksbank)
(This version: 09/2018; First version: 09/2018; Sveriges Riksbank Working Paper No. 357)

  • Abstract:

We use text analysis and a novel dataset to measure the sentiment component of central bank communications in 23 countries over the 2002-2017 period. Our analysis yields three key results. First, using directed networks, we show that comovement in sentiment across central banks is not reducible to trade or financial flow exposure. Second, we find that geographic distance is a robust and economically significant determinant of comovement in central bank sentiment, while shared language and colonial ties are economically significant, but less robust. Third, we use structural VARs to show that sentiment shocks generate cross-country spillovers in sentiment, policy rates, and macroeconomic variables. We also find that the Fed plays a uniquely influential role in generating such sentiment spillovers, while the ECB is primarily influenced by other central banks. Overall, our results suggest that central bank communication contains systematic biases that could lead to suboptimal policy outcomes. (JEL E52, E58, F42)

  • Keywords: communication, monetary policy, international policy transmission.

New version of “Bank Misconduct, Trust, and Online Lending”

“Bank Misconduct, Trust, and Online Lending” with Isaiah Hull (Sveriges Riksbank), Yingjie Qi (Stockholm School of Economics) and Xin Zhang (Sveriges Riksbank)

  • Abstract:

We study the impact of trust on the expansion of online lending in the U.S. over the 2008-2016 period. Using nearly complete loan and application data from the online lending market, we demonstrate that a misconduct-driven decline of trust in traditional banking is associated with a statistically and economically significant increase in online lending demand at the state and county levels. Furthermore, we show that this e↵ect is strongest for low rated borrowers and weakest in states with high levels of generalized trust. We also examine generalized trust in isolation and show that it strengthens in-person, bank-based borrowing, reducing the demand for impersonal online lending. Finally, we use a shock that affects only investors to demonstrate that distrust in traditional finance increases participation in online lending.

  • Keywords: financial development, consumer loans, bank misconduct, FinTech.

Revised version of “Fire Sale Bank Recapitalizations”

“Optimal Bank Capitalization in Crowded Markets” with Mike Mariathasan (KU Leuven)
(This version: 08/2017; First version: 09/2015; Sveriges Riksbank Working Paper No. 312)

  • Abstract:

We study banks’ optimal equity buffer in general equilibrium, as well as their ex-post response to under-capitalization. Developing a “pecking order theory” for private recapitalizations, our benchmark model identifies equity issuance as individually and socially optimal, compared to deleveraging, and conditions that invert the individually optimal ranking. Ex-ante, the imperfectly elastic supply of capital, incomplete insurance markets and costly bankruptcies give rise to inefficiently high capital shortfalls and excessive insolvencies. Abstracting from moral hazard and informational asymmetries, we therefore provide a novel rationale for macroprudential capital regulation emerges and a new set of testable implications about banks’ capital structure management.

  • Keywords: bank capital, macroprudential regulation, incomplete markets, financial market segmentation, constrained inefficiency.