Browsing by Subject "Financial Intermediation"

This dissertation presents a quantitative study on the relationship between financial intermediation and the macroeconomy of the United States. It consists of two major chapters, with the first chapter studying adverse shocks to interbank market lending, and with the second chapter studying a theoretical model where aggregate balance sheets of the financial and non-financial sectors play a key role in financial intermediation frictions.

In the first chapter, I empirically investigate a novel macroeconomic shock: the funding liquidity shock. Funding liquidity is defined as the ability of a (financial) institution to raise cash at short notice, with interbank market loans being a very common source of short-term external funding. Using the "TED spread" as a proxy of aggregate funding liquidity for the period from 1971M1 to 2009M9, I first discover that, by using the vector-autoregression approach, an unanticipated adverse TED shock brings significant recessionary effects: industrial production and prices fall, and the unemployment rate rises. The contraction lasts for about twenty months. I also recover the conventional monetary policy shock, the macro impact of which is in line with the results of Christiano et al (1998) and Christiano et al (2005) . I then follow the factor model approach and find that the excess returns of small-firm portfolios are more negatively impacted by an adverse funding liquidity shock. I also present evidence that this shock as a "risk factor" is priced in the cross-section of equity returns. Moreover, a proposed factor model which includes the structural funding liquidity and monetary policy shocks as factors is able to explain the cross-sectional returns of portfolios sorted on size and book-to-market ratio as well as the Fama and French (1993) three-factor model does. Lastly, I present empirical evidence that funding liquidity and market liquidity mutually affect each other.

I start the second chapter by showing that, in U.S. data, the balance sheet health of the financial sector, as measured by its equity capital and debt level, is a leading indicator of the balance sheet health of the nonfinancial sector. This fact, and the apparent role of the financial sector in the recent global financial crisis, motivate a general equilibrium macroeconomic model featuring the balance sheets of both sectors. I estimate and study a model within the "loanable funds" framework of Holmstrom and Tirole (1997), which introduces a double moral hazard problem in the financial intermediation process. I find that financial frictions modeled within this framework give rise to a shock transmission mechanism quantitatively different from the one that arises with the conventional modeling assumption, in New Keynesian business cycle models, of convex investment adjustment costs. Financial equity capital plays an important role in determining the depth and persistence of declines in output and investment due to negative shocks to the economy. Moreover, I find that shocks to the financial intermediation process cause persistent recessions, and that these shocks explain a significant portion of the variation in investment. The estimated model is also able to replicate some aspects of the cross-correlation structure of the balance sheet variables of the two sectors.

This dissertation consists of two essays on macropudential policies and financial frictions. In the first essay, the Reserve Option Mechanism, an unconventional policy tool invented and used by the Central Bank of the Republic of Turkey, is modeled and evaluated. The mechanism is designed to act as an automatic stabilizer of large fluctuations of exchange rate by letting banks use foreign currency to fulfill a portion of the domestic-denominated required reserves. Hence, the fluctuations in domestic business cycles due to volatile short-term capital flows are expected to be mitigated. The mechanism works through easing the frictions faced in the financial sector by generating a certain level of ``confidence" for the banks in terms of having enough foreign funding as reserves. Banks utilize the mechanism up to a point where this benefit is offset by the cost of using the mechanism: the Reserve Option Coefficient, which is the amount of foreign currency that must be held to meet one-unit domestic-denominated reserve requirement, i.e., an artificially imposed ``exchange rate". Two channels through which the mechanism is utilized are identified: a) the funding spread banks face between the foreign and domestic funding rates, and b) depreciation channel which involves the valuation of already-held foreign reserves through the mechanism.

In the second essay, I present a dynamic stochastic general equilibrium model that can be used to evaluate macroprudential policies. In the model, both the financial intermediaries and the non-financial firms face financial frictions and make separate financial decisions. After showing the model's relative ability to replicate events like the Great Recession compared to natural benchmark models, I document that financial shocks were relatively more important than productivity shocks in the period of the Great Recession. Then, I evaluate a countercyclical capital policy that can help mitigate both financial and productivity shocks. The policy involves injection of additional capital to the banks during bad times, which reduces the frictions banks face; as a result, it is welfare-improving.