Work in Progress
The Zero-Beta Interest Rate
with Ben Hebert, Pablo Kurlat, and Qitong Wang.
We use equity returns to construct a time-varying measure of what we call the zero- beta rate: the expected return of a stock portfolio orthogonal to the stochastic discount factor. In contrast to safe rates, the zero-beta rate fits the aggregate Euler equation remarkably well. It has a large and volatile spread with respect to the safe rate. This spread responds to monetary policy shocks, which move zero-beta and safe rates in opposite directions. We claim that the zero-beta rate is the correct intertemporal price and that the safe rate primarily reflects the behavior of a convenience yield on safe assets.
Firm Dynamic Hedging and the Labor Risk Premium (slides)
with Cedomir Malgieri and Christopher Tonetti.
The labor risk premium is a wedge in labor demand that reflects the covariance of the marginal product of labor with the employer’s stochastic discount factor. We build a heterogeneous-agent incomplete-market model to measure and understand the labor risk premium and its effect on macroeconomic aggregates. Persistent uninsurable idiosyncratic risk creates a dynamic hedging motive for labor demand and heterogenous labor risk premiums. High productivity firms have higher risk premiums, which create endogenous misallocation. Aggregate fluctuations in idiosyncratic risk change the distribution of risk premiums, and are reflected in time-varying labor and TFP wedges.
Risk Premium Shocks Can Create Inefficient Recessions
Di Tella and Hall (2021), Review of Economic Studies (accepted).
We develop a simple flexible-price model of business cycles driven by spikes in risk premiums. Aggregate shocks increase firms’ uninsurable idiosyncratic risk and raise risk premiums. We show that risk shocks can create quantitatively plausible recessions, with contractions in employment, consumption, and investment. Business cycles are inefficient—output, employment, and consumption fall too much during recessions, compared to the constrained-efficient allocation. Optimal policy involves stimulating employment and consumption during recessions.
Optimal Asset Management Contracts with Hidden Savings
Di Tella and Sannikov (2021), Econometrica, 89(3):1099-1139.
We characterize optimal asset management contracts in a classic portfolio-investment setting. When the agent has access to hidden savings, his incentives to misbehave depend on his precautionary saving motive. The contract dynamically distorts the agent’s access to capital to manipulate his precautionary saving motive and reduce incentives for misbehavior. We provide a sufficient condition for the validity of the first-order approach which holds in the optimal contract: global incentive compatibility is ensured if the agent’s precautionary saving motive weakens after bad outcomes. We extend our results to incorporate market risk, hidden investment, and renegotiation.
Why are Banks Exposed to Monetary Policy?
Di Tella and Kurlat (2021), AEJ:Macro, 13(4): 295-340.
We propose a model of banks’ exposure to movements in interest rates and their role in the transmission of monetary shocks. Since bank deposits provide liquidity, higher interest rates allow banks to earn larger spreads on deposits. Therefore, if risk aversion is higher than one, banks’ optimal dynamic hedging strategy is to take losses when interest rates rise. This risk exposure can be achieved by a traditional maturity-mismatched balance sheet, and amplifies the effects of monetary shocks on the cost of liquidity. The model can match the level, time pattern, and cross-sectional pattern of banks’ maturity mismatch.
Risk Premia and the Real Effects of Money
Di Tella (2020), American Economic Review, 110(7):1995-2040.
This paper proposes a flexible-price theory of the role of money in an economy with incomplete idiosyncratic risk sharing. When the risk premium goes up, money provides a safe store of value that prevents interest rates from falling, reducing investment. Investment is too high during booms when risk is low, and too low during slumps when risk is high. Monetary policy cannot correct this—money is superneutral and Ricardian equivalence holds. The optimal allocation requires the Friedman rule and a tax/subsidy on capital. The real effects of money survive even in the cashless limit.
Optimal Regulation of Financial Intermediaries
Di Tella (2019), American Economic Review, 109(1):271-313.
I characterize the optimal financial regulation policy in an economy where financial intermediaries trade capital assets on behalf of households, but must retain an equity stake to align incentives. Financial regulation is necessary because intermediaries cannot be excluded from privately trading in capital markets. They don’t internalize that high asset prices force everyone to bear more risk. The socially optimal allocation can be implemented with a tax on asset holdings. I derive a sufficient statistic for the externality in terms of observable variables, valid for heterogeneous intermediaries and asset classes, and arbitrary aggregate shocks. I use market data on leverage and volatility of intermediaries’ equity to measure the externality, which co-moves with the business cycle.
Uncertainty Shocks and Balance Sheet Recessions
Di Tella (2017), Journal of Political Economy, 125(6):2038-2081.
This paper investigates the origin and propagation of balance sheet recessions in a general equilibrium model with financial frictions. I first show that in standard models driven by TFP shocks, the balance sheet channel completely disappears when agents are allowed to write contracts on the aggregate state of the economy. Optimal contracts sever the link between leverage and aggregate risk sharing, eliminating the concentration of aggregate risk that drives balance sheet recessions. I then show how the type of aggregate shock that hits the economy can help explain the concentration of aggregate risk. In particular, I show that uncertainty shocks can drive balance sheet recessions and “flight to quality” events, even when contracts can be written on the aggregate state of the economy. Finally, I explore implications for financial regulation.