"Disputes, Debt and Equity," with Charles Nolan. Theoretical Economics (forthcoming).
We show how the prospect of disputes over firms’ revenue reports promotes debt financing over equity. This is demonstrated in a costly state verification model with a risk averse entrepreneur. The prospect of disputes encourages incentive contracts that limit penalties and avoid stochastic monitoring, even when the lender can commit to stochastic monitoring. Consequently, optimal contracts shift from equity toward standard debt. In short: When audit signals are weakly correlated with true incomes, standard debt contracts emerge as optimal; if audit signals are highly correlated with true incomes, optimal contracts resemble equity. When audit costs are sufficiently high, stochastic monitoring may be optimal. Optimal standard debt contracts under imperfect audits are shown to reproduce key empirical facts of US firm borrowing.
"Private information and aggregate risk sharing". Revise and resubmit at Journal of Mathematical Economics
When individuals have private information about their own luck and income,
the sharing of idiosyncratic risks is hampered by moral hazard. This friction also affects the optimal sharing of aggregate risks. Optimal allocations restrict the exposure of low wealth agents' consumption to business cycle risk. This encourages truth-telling by high wealth agents who have a high tolerance for aggregate risk, thereby increasing the extent to which idiosyncratic risks can be shared. Implementation of these optimal allocations requires restrictions in the trade of securities contingent on aggregate outcomes.
"Financial Frictions in Macroeconomic Models," with Charles Nolan. Oxford Research Encyclopedia of Economics and Finance, 2018.
In recent decades, macroeconomic researchers have looked to incorporate financial intermediaries explicitly into business-cycle models. These modeling developments have helped us to understand the role of the financial sector in the transmission of policy and external shocks into macroeconomic dynamics. They also have helped us to understand better the consequences of financial instability for the macroeconomy. Large gaps remain in our knowledge of the interactions between the financial sector and macroeconomic outcomes. Specifically, the effects of financial stability and macroprudential policies are not well understood.