Research Interests
Asset Pricing, Macro-Finance, Contract Theory and Firm Dynamics
Publications
Unified Model of Firm Dynamics with Limited Commitment and Assortative Matching, Journal of Finance
with Hengjie Ai, Dana Kiku and Rui Li
Abstract: We develop a unified theory of dynamic contracting and assortative matching to explain firm dynamics. In our model, the joint distribution of firm size, investment and managerial compensation is determined by the optimal contract where neither firms nor managers can commit to arrangements that yield lower payouts than their outside options. The outside options of both parties are micro-founded by the equilibrium conditions in a matching market. Our model endogenously generates power laws in firm size and CEO compensation and explains differences in their right tails. We also show that our model quantitatively accounts for many salient features of the time-series dynamics and the cross-sectional distribution of firm growth, dividend payout and CEO compensation.
Unified Model of Firm Dynamics with Limited Commitment and Assortative Matching, Journal of Finance
with Hengjie Ai, Dana Kiku and Rui Li
Abstract: We develop a unified theory of dynamic contracting and assortative matching to explain firm dynamics. In our model, the joint distribution of firm size, investment and managerial compensation is determined by the optimal contract where neither firms nor managers can commit to arrangements that yield lower payouts than their outside options. The outside options of both parties are micro-founded by the equilibrium conditions in a matching market. Our model endogenously generates power laws in firm size and CEO compensation and explains differences in their right tails. We also show that our model quantitatively accounts for many salient features of the time-series dynamics and the cross-sectional distribution of firm growth, dividend payout and CEO compensation.
Working Papers
Inflation risk and finance-growth nexus
with Alexandre Corhay, Revise & Resubmit, Review of Economic Studies
Abstract: This paper shows that the effect of inflation on asset prices and real aggregates depends on the financial intermediation sector. When firms finance using nominal long-term debt issued by financial intermediaries, unexpected changes in inflation lead to a wealth transfer across sectors. Higher inflation decreases firms' real liabilities and default risk, which helps reduce debt overhang. However, it hurts intermediaries' balance sheet, leading to a contraction in credit. We show theoretically that the ultimate effect of inflation depends on the tightness of financing constraints in the intermediation sector. We find strong empirical evidence consistent with these results. We also show that an inflation policy responding to both financial and real variables can help stabilize our economy.
with Alexandre Corhay, Revise & Resubmit, Review of Economic Studies
Abstract: This paper shows that the effect of inflation on asset prices and real aggregates depends on the financial intermediation sector. When firms finance using nominal long-term debt issued by financial intermediaries, unexpected changes in inflation lead to a wealth transfer across sectors. Higher inflation decreases firms' real liabilities and default risk, which helps reduce debt overhang. However, it hurts intermediaries' balance sheet, leading to a contraction in credit. We show theoretically that the ultimate effect of inflation depends on the tightness of financing constraints in the intermediation sector. We find strong empirical evidence consistent with these results. We also show that an inflation policy responding to both financial and real variables can help stabilize our economy.
Equilibrium Value and Profitability Premia
with Hengjie Ai, Jun E. Li, Revise & Resubmit, Journal of Finance
Abstract: Standard production-based asset pricing models cannot simultaneously explain the value and the profitability premia, because the value and the profitability factors are highly negatively correlated. Empirically, we show that value and profitability sorted portfolios differ in the persistence of productivity. We develop a general equilibrium model where firm-level productivity has a two factor structure with different persistence and demonstrate that heterogeneity in the persistence of productivity shocks can account for the coexistence of the profitability and the value premium.
with Hengjie Ai, Jun E. Li, Revise & Resubmit, Journal of Finance
Abstract: Standard production-based asset pricing models cannot simultaneously explain the value and the profitability premia, because the value and the profitability factors are highly negatively correlated. Empirically, we show that value and profitability sorted portfolios differ in the persistence of productivity. We develop a general equilibrium model where firm-level productivity has a two factor structure with different persistence and demonstrate that heterogeneity in the persistence of productivity shocks can account for the coexistence of the profitability and the value premium.
State Ownership and Monetary Supply Shocks: A Tale of Two Sector
with Frederico Belo, Dapeng Hao, Xiaoji Lin, Zhigang Qiu
Abstract: We investigate the impact of monetary supply shocks and state ownership on asset prices, corporate policies and capital allocation. By primarily focusing on corporations of China, we show that the relationship between expected returns and capital investment varies significantly across state owned enterprises (SOE) and private owned enterprises (POE). The investment return spread - the average returns of a long low investment and short high investment firms - is about 5% per annum in the SOE sector, but close to zero in the POE sector. We show that the difference in the relationship between expected returns and investment across SOE and POE firms is driven by their differential exposures to the monetary supply shocks in China. Because SOE firms have easier access to bank loans, the high investment firms in the SOE sector can still raise debt to finance their investments when debt supply shrinks, and hence they are less risky. We develop a dynamic model with monetary supply shocks and SOE and POE firms facing different frictions in debt markets. The economic mechanism emphasizes that heterogeneous access to the debt market is an important determinant of equilibrium risk premiums and capital misallocation across sectors with different state ownership.
with Frederico Belo, Dapeng Hao, Xiaoji Lin, Zhigang Qiu
Abstract: We investigate the impact of monetary supply shocks and state ownership on asset prices, corporate policies and capital allocation. By primarily focusing on corporations of China, we show that the relationship between expected returns and capital investment varies significantly across state owned enterprises (SOE) and private owned enterprises (POE). The investment return spread - the average returns of a long low investment and short high investment firms - is about 5% per annum in the SOE sector, but close to zero in the POE sector. We show that the difference in the relationship between expected returns and investment across SOE and POE firms is driven by their differential exposures to the monetary supply shocks in China. Because SOE firms have easier access to bank loans, the high investment firms in the SOE sector can still raise debt to finance their investments when debt supply shrinks, and hence they are less risky. We develop a dynamic model with monetary supply shocks and SOE and POE firms facing different frictions in debt markets. The economic mechanism emphasizes that heterogeneous access to the debt market is an important determinant of equilibrium risk premiums and capital misallocation across sectors with different state ownership.
Markup Shocks and Asset Prices
with Alexandre Corhay, Jun E. Li
Abstract: We explore the asset pricing implications of shocks that allow firms to extract more rents from consumers. These markup shocks directly impact the representative household’s marginal utility and the firms' cash flow. Using firm-level data, we construct a measure of aggregate markup shocks and show that the price of markup risk is negative, that is, a positive markup shock is associated with high marginal utility states. Markup shocks generate differences in risk premia due to their heterogeneous impact on firms. Firms that have larger exposures to markup shocks are less risky and have lower expected returns. We rationalize these findings in a general equilibrium model with markup shocks.
with Alexandre Corhay, Jun E. Li
Abstract: We explore the asset pricing implications of shocks that allow firms to extract more rents from consumers. These markup shocks directly impact the representative household’s marginal utility and the firms' cash flow. Using firm-level data, we construct a measure of aggregate markup shocks and show that the price of markup risk is negative, that is, a positive markup shock is associated with high marginal utility states. Markup shocks generate differences in risk premia due to their heterogeneous impact on firms. Firms that have larger exposures to markup shocks are less risky and have lower expected returns. We rationalize these findings in a general equilibrium model with markup shocks.
A Dynamic-Agency Based Asset Pricing Theory with Production
with Chao Ying
Abstract: We develop a general equilibrium model based on dynamic agency theory to study investment and asset prices. In our environment, neither firms nor workers can commit to compensation contracts that provide continuation values below their outside options. At the aggregate level, the presence of agency frictions amplifies the market price of risks and allows our model to generate a sizable equity premium with a low level of risk aversion. History dependent labor contracts generate a form of operating leverage and allow our model to match the key features of the aggregate and cross-section of investment and equity returns in the data. A variance decomposition of investment into discount rate news and cash flow news supports the mechanism of our model.
with Chao Ying
Abstract: We develop a general equilibrium model based on dynamic agency theory to study investment and asset prices. In our environment, neither firms nor workers can commit to compensation contracts that provide continuation values below their outside options. At the aggregate level, the presence of agency frictions amplifies the market price of risks and allows our model to generate a sizable equity premium with a low level of risk aversion. History dependent labor contracts generate a form of operating leverage and allow our model to match the key features of the aggregate and cross-section of investment and equity returns in the data. A variance decomposition of investment into discount rate news and cash flow news supports the mechanism of our model.