This paper studies the welfare properties of competitive equilibria in an economy with incomplete markets subject to idiosyncratic and aggregate shocks. We focus on the role of securitization, whereby borrowers can reduce idiosyncratic asset risk, which enables increased leverage and investment....

A recent literature shows how an increase in volatility reduces leverage. However, in order to explain pro-cyclical leverage it assumes that bad news increases volatility, that is, it assumes an inverse relationship between first and second moments of asset returns. This paper suggests a reason...

We show how the timing of financial innovation might have contributed to the mortgage bubble and then to the crash of 2007-2009. We show why tranching and leverage first raised asset prices and why CDS lowered them afterwards. This may seem puzzling, since it implies that creating a derivative...

A recent literature shows how an increase in volatility reduces leverage. However, in order to explain pro-cyclical leverage it assumes that bad news increases volatility, that is, it assumes an inverse relationship between first and second moments of asset returns. This paper suggests a reason...

Recently Andersen and Bondarenko posted a paper on SSRN with the title “VPIN and the Flash Crash” which is essentially a comment on our earlier work on the measure of order toxicity, VPIN. Andersen and Bondarenko dispute our empirical findings and argue that VPIN essentially doesn't work. We...

This Policy Analysis explains the antecedents of the current global financial crisis and critically examines the reasoning behind the U.S. Treasury and Federal Reserve's actions to prop up the financial sector. It argues that recovery from the financial crisis is likely to be slow with or...

We show that cross-border financial flows arise when countries differ in their abilities to use assets as collateral. Financial integration is a way of sharing scarce collateral. The ability of one country to leverage and tranche assets provides attractive financial contracts to investors in the...

The ‘flash crash' of May 6th 2010 was the second largest point swing (1,010.14 points) and the biggest one-day point decline (998.5 points) in the history of the Dow Jones Industrial Average. For a few minutes, $1 trillion in market value vanished. In this paper, we argue that the ‘flash...

The steady application of Quantitative Easing (QE) has been followed by big and non-monotonic effects on international asset prices and international capital flows. These are difficult to explain in conventional models, but arise naturally in a model with collateral. This paper develops a...

The steady application of Quantitative Easing (QE) has been followed by big and non-monotonic effects on international asset prices and international capital flows. These are difficult to explain in conventional models, but arise naturally in a model with collateral. This paper develops a...