Saki Bigio

We introduce a dynamic bank theory featuring delayed loss recognition and a regulatory capital constraint, aiming to match the bank leverage dynamics captured by Tobin’s Q. We start from four facts: (1) book and market equity values diverge, especially during crises; (2) Tobin’s Q predicts future bank profitability; (3) neither book nor market leverage constraints are strictly binding for most banks; and (4) bank leverage and Tobin’s Q are mean reverting but highly persistent. We demonstrate that delayed loss accounting rules interact with bank capital requirements, introducing a tradeoff between loan growth and financial fragility. Our welfare analysis implies that accounting rules and capital regulation should optimally be set jointly. This paper emphasizes the need to reconcile regulatory dependence on book values with the market’s emphasis on fundamental values to enhance understanding of banking dynamics and improve regulatory design.

Speculation, in the spirit of Harrison and Kreps (1978), is introduced into a standard real business cycle model. Investors (speculators) hold heterogeneous beliefs about firm growth. Firm ownership, and thus, the firm’s discount factor varies with waves of optimism and leverage. These waves ripple into firm investments in hours. The firm’s discount factor links the equity premium and labor volatility puzzles. We obtain an upper bound to the amplification that can be generated by speculation for any model of beliefs—a factor of 1.5. A calibration based on diagnostic beliefs amplifies hours volatility by a factor of 1.15 and produces a bubble component of 20 percent.

We present a simple dynamic model of OTC markets. When the market opens, agents with a cash deficit search for lenders with cash surplus. By a closing time, positions that remain open are closed with a lender of last resort. We derive a closed form solution for the liquidity yield function, a function that maps a settlement deficit/surplus into a settlement cost/benefit. This is a kinked function whose slope depends on features of the OTC market and the distribution of settlement needs. The liquidity yield enters as an additional consideration in portfolio theory.

We present a theory of the asset and liability composition of bank balance sheets. Trade requires the use of assets as means of payments. Because of information asymmetries, some assets are poor means of payment: they are illiquid and do not circulate. Banks swap those assets for their liabilities. Banks' liabilities can be designed to circulate although fully backed by assets that do not. Liquid assets, that could circulate on their own, are brought to the banks' balance sheet to enhance liquidity creation. Hence, liquid and illiquid assets are complementary factors for liquidity creation. We study banks' asset choice and liability design and implement it with standard instruments, such as saving deposits, time deposits, and bank loans. We argue that the optimal asset and liability composition resembles bank balance sheets in practice.

This paper integrates an implementation of monetary policy through the banking system into an incomplete-markets economy with nominal rigidity. Monetary policy sets policy rates and alters the supply of reserves. These tools grant independence control over credit spreads and an interest-rate target. Through these tools, monetary policy affects the evolution of real interest rates, credit, output, and the wealth distribution. We decompose their effects into a combination of the interest and credit channels that depend on the size of the central bank’s balance sheet. The model provides insights regarding when are counter-cyclical central bank balance sheets ideal. This model highlights a trade-off between worse micro economic insurance (insurance across agents) and better macroeconomic insurance (insurance across states).

This paper analyzes the optimal debt maturity of a small open economy that issues finite-life bonds of different maturity. The economy faces aggregate shocks to income and risk-free rates, and default is an option. Bond issuance is subject to liquidity costs. The optimal debt-maturity profile reflects four forces: (i) (partial) hedging, (ii) self-insurance, (iii) credit risk, and (iv) incentives to avoid debt dilution.

We calibrate the model to Spain and estimate the relative weight of each of these forces in shaping the volume and optimal maturity of debt. We conclude that hedging is the most important force. Finally, we analyze how debt issuances should change in the event of a permanent increase in interest rates.

A follow up on the earlier work in “Debt-Maturity Management with Liquidity Costs“ Journal of Political Economy: Macroeconomics, March 2023, Volume 1, Number 1, pages 119-190, joint with Galo Nuño, and Juan Passadore

We append the expectation of a monetary-fiscal reform into a standard new-Keynesian model. Under the reform, monetary policy is temporarily obliged to provoke inflation to aid the government make its debt sustainable. After the reform, debt and inflation are stabilized again. We study the fight against inflation prior to the realization of an expected reform. Temporary increases in nominal rates carry two effects: a standard deflationary effect through aggregate demand and an inflationary effect through expected future inflation. Expected future inflation follows because higher rates increase the fiscal debt burden, signaling that greater inflation may occur in the future. While the standard demand effect can reduce inflation on impact, inflation returns more strongly through the effect on expectations (sticky inflation). An optimal commitment policy allows for trend in inflation to reduce the debt burden until a fiscal reform takes place.