Abstract: I show that capital is misallocated across liquidity pools on blockchain-based decentralized exchanges. Many pools have persistent abnormal returns, both with respect to factor models and compared to options-implied liquidity premia. Pools with higher past returns continue to have significantly higher risk-adjusted future returns. I show that this return predictability arises because liquidity flow is insensitive to net returns. Instead, liquidity providers chase fee revenues -- the part of return that is prominently marketed as APY -- but ignore adverse selection losses -- the part of return that is implicit and rarely displayed. As a result, pools with higher fee revenues attract more liquidity, even though they tend to have higher adverse selection losses driven by information or sentiment and insignificant returns on net. Aggregate liquidity on decentralized exchanges would have shrunk by one third if liquidity providers were equally sensitive to adverse selection losses.
Abstract: I show that the rise of bond mutual funds and ETFs ("bond funds") amplifies the bond market transmission of monetary policy. During monetary easing (tightening) cycles, bond funds experience significantly larger increase (decrease) in flows than other institutional bond investors. Bond funds proportionally scale their bond holdings in response to flows, generating large price pressure on bonds that amplifies the monetary sensitivity of bond yields and bond issuance. For identification, I exploit cross-sectional heterogeneity in exposure to bond fund flows. In response to monetary easing, more-exposed corporate bonds experience higher temporary returns, and more-exposed firms issue more bonds and increase leverage, equity payout and real investment. To assess the aggregate effect, I use a demand system framework that allows for inelastic substitution both within and across bond classes. Under a partial equilibrium decomposition, bond fund flows account for 21% of the aggregate corporate bond yield sensitivity to monetary policy, which has increased over time with the rise of bond funds.
Abstract: Sovereign debt crises are difficult to solve. This paper studies the “holdout problem,” meaning the risk that creditors refuse to participate in a debt restructuring. We document a large variation in holdout rates, based on a comprehensive new dataset of 23 bond restructurings with external creditors since 1994. We then study the determinants of holdouts and find that the size of creditor losses (haircuts) is among the best predictors at the bond level. In a restructuring, bonds with higher haircuts see higher holdout rates, and the same is true for small bonds and those issued under foreign law. Collective action clauses (CACs) are effective in reducing holdout risks. However, classic CACs, with bond-by-bond voting, are not sufficient to assure high participation rates. Only the strongest form of CACs, with single-limb aggregate voting, minimizes the holdout problem according to our simulations. The results help to inform theory as well as current policy initiatives on reforming sovereign bond markets.
TA for FNCE 250/750 Venture Capital and the Financing of Innovation
TA for FNCE 206/717 Financial Derivatives