Abstract: In postwar U.S. data, recessions are often accompanied by rising macroeconomic uncertainty and a falling private sector investment share. I rationalize this pattern in a two-sector general equilibrium model that features exogenous variations in uncertainty and endogenous (mis)allocation of capital between the private and public sectors. The model demonstrates a risk-based mechanism that not only produces the “flight to safety” phenomenon in financial markets but also drives the compositional changes in aggregate investment. With this distinctive mechanism, the model predicts that: (i) there is a positive (negative) relationship between the public (private) sector investment rate and firms’ risk premiums; (ii) an increase in aggregate uncertainty in the private sector is associated with a decrease in the private sector investment share as well as a decrease in the real short rate; (iii) controlling for uncertainty, a larger private sector investment share is associated with a lower real short rate. These predictions are consistent with the empirical evidence.
Abstract: Independent technological glitches forced two separate trading halts on different U.S. exchanges during the week of July 6, 2015. During each halt, all other exchanges remained open. We exploit exogenous variation provided by this unprecedented coincidence, in conjunction with a proprietary data set, to identify the causal impact of Designated Market Maker (DMM) participation on liquidity. When the voluntary liquidity providers on one exchange were removed, liquidity remained unchanged; when DMMs were removed, liquidity decreased market-wide. We find evidence consistent with the idea that these DMMs, despite facing only mild formal obligations, significantly improve liquidity in the modern electronic marketplace.