“If you’re going to try, go all the way. Otherwise, don’t even start.” — Charles Bukowski
Abstract: I assess the overall supply of public sector capital in the U.S. through the lens of asset prices. Using a two-sector general equilibrium model, I demonstrate how the supply of public sector capital may become a source of priced risk, for which the price of risk changes sign as public sector capital becomes over- or under-supplied. Taking two complementary empirical approaches, I find consistent results suggesting that assets with higher sensitivity to variations in public investment have higher average returns. Together my findings imply that public sector capital is undersupplied, and greater public investment is favorable for investors.
Abstract: We study the effect of idiosyncratic uncertainty on asset prices, investment, and welfare. We consider an economy with two main ingredients: i) investors are constrained to hold under-diversified portfolios; ii) idiosyncratic risk is endogenous and countercyclical. We show that the equilibrium is constrained inefficient, being subject to underinvestment and excessive aggregate risk taking. Inefficiencies stem from the presence of an idiosyncratic risk externality, a form of pecuniary externality, as firms do not internalize the effect of their investment decisions on the risk borne by others. We provide a sufficient statistic for the magnitude of risk externalities, that depends on an idiosyncratic risk premium and a variance risk premium, and assess its magnitude empirically. We characterize the optimal allocation and show it can be implemented by financial regulation using a combination of a tax shield on debt and risk-weighted capital requirements.
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.