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Junfeng Qiu

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UNAM Universidad Nacional Autónoma de México

Enrique Kawamura

Universidad de San Andres - Argentina

Columbia University

Institute for Advanced Development Studies (INESAD)

Yoram Landskroner

Gauti Eggertsson

Gaetano Antinolfi

Jose Francisco Jorge

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Papers by Junfeng Qiu

Essays on the financial system and the transmission of monetary policy

This thesis studies the role of the banking system in several aspects of the macroeconomy, includ... more This thesis studies the role of the banking system in several aspects of the macroeconomy, including the likelihood of financial crises, volatility of asset prices and the transmission of monetary policy. In chapter 2, I analyze the accumulation of international reserves by central banks as insurance against financial crises. In the model, private banks borrow from foreign creditors to invest in domestic projects. By lending to banks in response to liquidity shocks, the central bank can reduce the liquidation of bank assets and lower the probability of bank runs. I show that the central bank will hold more reserves when private banks hold lower reserves. I also find that if the central bank can borrow additional loans from external sources, then domestic banks will hold fewer reserves by themselves. If the borrowing cost of external loan is very high, then the central bank may actually want to accumulate more reserves in order to avoid borrowing from external sources at high costs. ...

The Signaling Effect and Optimal LOLR Policy

When a central bank implements the LOLR policy in a financial crisis, bank creditors often infer ... more When a central bank implements the LOLR policy in a financial crisis, bank creditors often infer a bankâ€™s quality from whether or not it borrows from the central bank. We establish a formal model to study the optimal LOLR policy in the presence of this signaling effect, assuming that the central bank aims to encourage central bank borrowing to avoid inefficiencies caused by contagion. In our model, there are two types of banks: a high quality type with high expected asset returns and a low quality type with lower returns. Both types of banks need to roll over their short-term debts. A central bank offers to lend to both types of banks. After private creditors observe whether banks borrow from the central bank, banks try to borrow from the private market. We find that there may exist a separating equilibrium where only low quality banks borrow from the central bank; and two pooling equilibria where both types of banks do and do not borrow from the central bank. Our major results ar...

Central bank screening, moral hazard, and the lender of last resort policy

This paper establishes a theoretical model to examine the LOLR policy when a central bank can dis... more This paper establishes a theoretical model to examine the LOLR policy when a central bank can distinguish solvent banks from insolvent ones only imperfectly. The major results that our model produces are as follows: (1) The pooling equilibria in which, on one hand, all the banks borrow from the central bank and, on the other hand, all the banks do not borrow from the central bank could exist given certain market beliefs off the equilibrium path. However, neither equilibrium is socially efficient because insolvent banks will continue to hold their unproductive assets, rather than efficiently liquidating them. (2) Higher precision in central bank screening will improve social welfare not only by identifying insolvent banks and forcing them to efficiently liquidate their assets, but also by reducing moral hazard and deterring banks from choosing risky assets in the first place. (3) If a central bank can commit to a specific precision level before the banks choose their assets, rather t...

The LOLR Policy and its Signaling Effect in a Time of Crisis

Journal of Financial Services Research

When a government implements an LOLR policy during a crisis, creditors can infer a bank’s quality... more When a government implements an LOLR policy during a crisis, creditors can infer a bank’s quality by whether the bank borrows government loans. We establish a formal model to study an LOLR policy in the presence of this signaling effect. We find that three equilibria exist: a separating equilibrium where only low quality banks borrow from the government and two pooling equilibria where both high and low quality banks do and do not borrow from the government. Further, we find that the government’s lending rate serves an important signaling role and that hiding the identity of the banks that borrow government loans tends to encourage banks to do so. We also find two welfare effects of the LOLR policy: the liquidation cost saving and moral hazard. Depending on which effect dominates, the optimal LOLR policy differs.

Uncertainty in an Interconnected Financial System, Contagion, and Market Freezes

Journal of Money, Credit and Banking

Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch ge... more Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may be saved and copied for your personal and scholarly purposes. You are not to copy documents for public or commercial purposes, to exhibit the documents publicly, to make them publicly available on the internet, or to distribute or otherwise use the documents in public. If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence.

Uncertainty in an Interconnected Financial System, Contagion, and Market Freezes

Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch ge... more Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may be saved and copied for your personal and scholarly purposes. You are not to copy documents for public or commercial purposes, to exhibit the documents publicly, to make them publicly available on the internet, or to distribute or otherwise use the documents in public. If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence.

Elastic Money, Settlement, and Interest Rate Policy

The transmission of monetary policy is studied in an environment in which aggregate liquidity sho... more The transmission of monetary policy is studied in an environment in which aggregate liquidity shocks affect agents asymmetrically. Agents are subject to random liquidity requirements and interact with banks which both take deposits and make loans. Banks may issue loans in excess of their deposits but face liquidity constraints due to settlement requirements which are satisfied using fiat money created by the central bank. The total money supply is determined endogenously by credit transactions. Changes in the overall money stock have different implications for prices and inflation depending on whether they are associated with growth in the supply of central bank issued (outside) money or with money creation by private banks (inside money). By affecting the price level, changes in the quantity of inside money redistribute wealth. The central bank can control the interest rate and may improve welfare by adjusting it in response to aggregate shocks in order to mitigate the effects of price level increases on agents who have access only to their monetary savings. The effectiveness of this interest rate policy depends on the average inflation rate-in particular the policy becomes ineffective when the nominal interest rate is sufficiently low.

Asymmetric information and conversion price reset policy: The case of Chinese convertible debt

The Journal of Economic Asymmetries, 2015

This paper studies a firm's decision to reset the conversion price of convertible debt when the m... more This paper studies a firm's decision to reset the conversion price of convertible debt when the manager has asymmetric private information. Reset provisions are present uniquely in East Asian issues of convertible debt, and in practice allow a firm's management to lower the conversion price. We develop a signalling model in which a conversion price reset conveys unfavorable private information about the firm. This is because a firm will reset only if it cannot afford debt repayment. We conduct an event study with data on the equity prices of Chinese convertible bond issuing firms. We argue that conversion price resets exhibit negative announcement effects.

Bank money, asset prices and the financial liquidity channel of monetary policy

This paper extends the recent literature of "liquidity and asset prices" into monetary ... more This paper extends the recent literature of "liquidity and asset prices" into monetary models by adding money-creating banks. We explain why the money creation function of banks is important to financial stability. We study an economy in which not all assets can be used to make payments, agents may have to sell assets when they need cash. Sale of assets can lead to low asset price because buyers have limited ability to buy assets. Banks can provide liquidity by creating and lending out new deposit. This will reduce the sale of assets and stabilize asset prices. We also compare two types of liquidity provision mechanisms: liquidity-risk sharing through coalitions and liquidity provision through money creation. We show that if people use mutual-fund-like non-bank coalitions to share liquidity risks, then the function of banks to relax the aggregate money constraint is important. Without banks, non-bank coalitions will not be able to insure against aggregate liquidity risks, ...

Banks as dealers of credit money: Comparing the roles of banks and non-banks in the provision of liquidity

Using a general equilibrium monetary model for banks, we analyze the role of banks in providing l... more Using a general equilibrium monetary model for banks, we analyze the role of banks in providing liquidity to the financial market and the transmission of the financial liquidity channel of monetary policy. In the model, the roles of banks in the payment system give banks additional abilities to provide liquidity. Because bank deposits can be used as means of payment, banks can directly create and lend new deposits that are not backed by money collected from depositors. As a result, the private banking system has the ability to supply loans elastically to meet the stochastic liquidity needs of the economy with very little need to borrow from the central bank. We show that the existence of banks is important to non-banks. When aggregate liquidity is limited, the attempt of non-bank investment funds to provide more liquidity insurance to shareholders may lead to higher volatility in asset prices without actually giving more liquidity to shareholders. New inside money provided by banks ...

Bank money, aggregate liquidity, and asset prices

Annals of Economics and Finance

We build a general equilibrium model to analyze how the ability of banks to create money can affe... more We build a general equilibrium model to analyze how the ability of banks to create money can affect asset prices and financial stability. In the model, demand for liquidity takes the form of demand for money to make payments. We show that banks can provide elastic aggregate liquidity by creating and lending out deposits, which will reduce the need for people to sell assets and help maintain asset price stability. We also compare two types of liquidity provision mechanisms. The first is liquidity-risk-sharing through a Diamond-and-Dybvig style coalition that pools together people¡¯s resources, and the second is liquidity provision by banks though money creation. We show that without elastic aggregate liquidity provided by banks, coalitions can not actually perform their risk-sharing function, their attempt to sell assets to raise liquidity will only make asset prices decrease further, without actually raising more liquidity for shareholders hit by liquidity shocks. However, with bank...

Elastic Money, Inflation, And Interest Rate Policy

Optimal monetary policy is studied in an environment in which money plays an essential role in fa... more Optimal monetary policy is studied in an environment in which money plays an essential role in facilitating exchange and aggregate shocks affect individual agents asymmetrically. Exchange may be conducted using either bank deposits (inside money) or fiat currency (outside money). A central monetary authority both controls the stock of outside money and pursues an interest rate policy that affects the rate at which private banks create inside money. We find that the optimal monetary policy requires management of both interest rates and the quantity of outside money. By controlling interest rates the monetary authority can affect the price level in the short-run and adjust households' consumption, thus providing insurance against unfavorable aggregate shocks. The feasibility of the interest rate policy requires a minimum rate of trend inflation that may be positive and in principle quite large. The paper thus links two principal components of monetary policy: the optimal interest ...

Effect of Short-sale Constraints on Stock Price Manipulation

Pacific Economic Review, 2013

ABSTRACT This paper examines the effect of short‐sale constraints on the stock price manipulation... more ABSTRACT This paper examines the effect of short‐sale constraints on the stock price manipulation of an insider, who is subject to mandatory disclosure rules. We show that the privately informed insider may manipulate by trading against his or her information when short selling is banned. We find that stock price movement is asymmetric in the sense that prices fall by a larger percentage than they rise. In addition, we prove that removing short‐sale constraints increases price volatility. Finally, we explore the welfare implications of short‐sale constraints.

Influx endogne de capitaux spculatifs et sentier optimal d'apprciation de la monnaie

Abstract This paper examines the optimal appreciation path of an undervalued currency in the pres... more Abstract This paper examines the optimal appreciation path of an undervalued currency in the presence of speculative capital inflows that are endogenously affected by the appreciation path. A central bank decides its appreciation policy based on three costs: (i) misalignment costs associated with the gap between the actual and long-run equilibrium exchange rates, (ii) short-term adjustment costs due to resource reallocation, and (iii) capital losses due to speculative capital inflows. Our model finds (1) when speculators face no liquidity shocks, the central bank tends to appreciate the currency quickly to discourage speculative capital; (2) when speculators face liquidity shocks, the central bank optimally pre-commits to a slower appreciation path, and the appreciation takes the longest time when the probability of liquidity shocks takes intermediate values; (3) the central bank tends to appreciate the currency more quickly when it conducts discretionary policy. Ce mmoire examine l...

Elastic Money, Settlement, and Interest Rate Policy

by Junfeng Qiu and Allen Head

The transmission of monetary policy is studied in an environment in which aggregate liquidity sho... more The transmission of monetary policy is studied in an environment in which aggregate liquidity shocks affect agents asymmetrically. Agents are subject to random liquidity requirements and interact with banks which both take deposits and make loans. Banks may issue loans in excess of their deposits but face liquidity constraints due to settlement requirements which are satisfied using fiat money created by the central bank. The total money supply is determined endogenously by credit transactions. Changes in the overall money stock have different implications for prices and inflation depending on whether they are associated with growth in the supply of central bank issued (outside) money or with money creation by private banks (inside money). By affecting the price level, changes in the quantity of inside money redistribute wealth. The central bank can control the interest rate and may improve welfare by adjusting it in response to aggregate shocks in order to mitigate the effects of p...

Convertible bonds with resettable conversion prices

Economic Modelling, 2013

ABSTRACT We examine the convertible bonds whose conversion prices can be reset under certain cond... more ABSTRACT We examine the convertible bonds whose conversion prices can be reset under certain conditions, by extending the asymmetric information framework of Stein (1992). These convertibles are more common in Japan and China and are in sharp contrast with the convertible bonds with fixed conversion prices. We find that resettable convertibles can help firms reduce liquidity cost. But the adverse selection problem caused by bad firms may be exacerbated if the cost of financial distress is not sufficiently high. Firms can mitigate the problem through costly signaling with fixed-price convertibles. Finally, we show that pooling and separating equilibria may coexist for some parameter values.

Speculative capital inflows, adaptive expectations, and the optimal renminbi appreciation policy

China Economic Review, 2013

ABSTRACT This paper examines empirical evidence of the adaptive learning behavior of speculators ... more ABSTRACT This paper examines empirical evidence of the adaptive learning behavior of speculators in the 2005–2008 renminbi appreciation episode, and establishes a theoretical model to explore appreciation policy implications of such a behavior. In our model, speculators form their expectations about the future appreciation premium adaptively by extrapolating past appreciation returns into the future. We find that a rapid appreciation may attract more capital inflows, and the central bank may prefer a slow appreciation to discourage capital inflows. Simulated results can generate hump-shaped paths of the appreciation speed, expected appreciation premium, and capital inflows. In addition, changes in the appreciation speed precede changes in the expected appreciation premium and capital inflows. These results are consistent with empirical evidence in the 2005–2008 renminbi appreciation episode.

Endogenous inflows of speculative capital and the optimal currency appreciation path

Canadian Journal of Economics/Revue canadienne d'économique, 2011

This paper examines the optimal appreciation path of an undervalued currency in the presence of s... more This paper examines the optimal appreciation path of an undervalued currency in the presence of speculative capital inflows that are endogenously affected by the appreciation path. A central bank decides its appreciation policy based on three costs: (i) misalignment costs associated with the gap between the actual and long-run equilibrium exchange rates, (ii) short-term adjustment costs due to resource reallocation, and (iii) capital losses due to speculative capital inflows. Our model finds (1) when speculators face no liquidity shocks, the central bank tends to appreciate the currency quickly to discourage speculative capital; (2) when speculators face liquidity shocks, the central bank optimally pre-commits to a slower appreciation path, and the appreciation takes the longest time when the probability of liquidity shocks takes intermediate values;

Elastic money, inflation and interest rate policy

by Junfeng Qiu and Allen Head

We study optimal monetary policy in an environment in which money plays a basic role in facilitat... more We study optimal monetary policy in an environment in which money plays a basic role in facilitating exchange, aggregate shocks affect households asymmetrically and exchange may be conducted using either bank deposits (inside money) or fiat currency (outside money). A central bank controls the stock of outside money in the long-run and responds to shocks in the short-run using an interest rate policy that manages private banks' creation of inside money and influences households' consumption. The zero bound on nominal interest rates prevents the central bank from achieving efficiency in all states. Long-run inflation can improve welfare by mitigating the effect of this bound.

Essays on the financial system and the transmission of monetary policy

This thesis studies the role of the banking system in several aspects of the macroeconomy, includ... more This thesis studies the role of the banking system in several aspects of the macroeconomy, including the likelihood of financial crises, volatility of asset prices and the transmission of monetary policy. In chapter 2, I analyze the accumulation of international reserves by central banks as insurance against financial crises. In the model, private banks borrow from foreign creditors to invest in domestic projects. By lending to banks in response to liquidity shocks, the central bank can reduce the liquidation of bank assets and lower the probability of bank runs. I show that the central bank will hold more reserves when private banks hold lower reserves. I also find that if the central bank can borrow additional loans from external sources, then domestic banks will hold fewer reserves by themselves. If the borrowing cost of external loan is very high, then the central bank may actually want to accumulate more reserves in order to avoid borrowing from external sources at high costs. ...

The Signaling Effect and Optimal LOLR Policy

When a central bank implements the LOLR policy in a financial crisis, bank creditors often infer ... more When a central bank implements the LOLR policy in a financial crisis, bank creditors often infer a bankâ€™s quality from whether or not it borrows from the central bank. We establish a formal model to study the optimal LOLR policy in the presence of this signaling effect, assuming that the central bank aims to encourage central bank borrowing to avoid inefficiencies caused by contagion. In our model, there are two types of banks: a high quality type with high expected asset returns and a low quality type with lower returns. Both types of banks need to roll over their short-term debts. A central bank offers to lend to both types of banks. After private creditors observe whether banks borrow from the central bank, banks try to borrow from the private market. We find that there may exist a separating equilibrium where only low quality banks borrow from the central bank; and two pooling equilibria where both types of banks do and do not borrow from the central bank. Our major results ar...

Central bank screening, moral hazard, and the lender of last resort policy

This paper establishes a theoretical model to examine the LOLR policy when a central bank can dis... more This paper establishes a theoretical model to examine the LOLR policy when a central bank can distinguish solvent banks from insolvent ones only imperfectly. The major results that our model produces are as follows: (1) The pooling equilibria in which, on one hand, all the banks borrow from the central bank and, on the other hand, all the banks do not borrow from the central bank could exist given certain market beliefs off the equilibrium path. However, neither equilibrium is socially efficient because insolvent banks will continue to hold their unproductive assets, rather than efficiently liquidating them. (2) Higher precision in central bank screening will improve social welfare not only by identifying insolvent banks and forcing them to efficiently liquidate their assets, but also by reducing moral hazard and deterring banks from choosing risky assets in the first place. (3) If a central bank can commit to a specific precision level before the banks choose their assets, rather t...

The LOLR Policy and its Signaling Effect in a Time of Crisis

Journal of Financial Services Research

When a government implements an LOLR policy during a crisis, creditors can infer a bank’s quality... more When a government implements an LOLR policy during a crisis, creditors can infer a bank’s quality by whether the bank borrows government loans. We establish a formal model to study an LOLR policy in the presence of this signaling effect. We find that three equilibria exist: a separating equilibrium where only low quality banks borrow from the government and two pooling equilibria where both high and low quality banks do and do not borrow from the government. Further, we find that the government’s lending rate serves an important signaling role and that hiding the identity of the banks that borrow government loans tends to encourage banks to do so. We also find two welfare effects of the LOLR policy: the liquidation cost saving and moral hazard. Depending on which effect dominates, the optimal LOLR policy differs.

Uncertainty in an Interconnected Financial System, Contagion, and Market Freezes

Journal of Money, Credit and Banking

Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch ge... more Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may be saved and copied for your personal and scholarly purposes. You are not to copy documents for public or commercial purposes, to exhibit the documents publicly, to make them publicly available on the internet, or to distribute or otherwise use the documents in public. If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence.

Uncertainty in an Interconnected Financial System, Contagion, and Market Freezes

Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch ge... more Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may be saved and copied for your personal and scholarly purposes. You are not to copy documents for public or commercial purposes, to exhibit the documents publicly, to make them publicly available on the internet, or to distribute or otherwise use the documents in public. If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence.

Elastic Money, Settlement, and Interest Rate Policy

The transmission of monetary policy is studied in an environment in which aggregate liquidity sho... more The transmission of monetary policy is studied in an environment in which aggregate liquidity shocks affect agents asymmetrically. Agents are subject to random liquidity requirements and interact with banks which both take deposits and make loans. Banks may issue loans in excess of their deposits but face liquidity constraints due to settlement requirements which are satisfied using fiat money created by the central bank. The total money supply is determined endogenously by credit transactions. Changes in the overall money stock have different implications for prices and inflation depending on whether they are associated with growth in the supply of central bank issued (outside) money or with money creation by private banks (inside money). By affecting the price level, changes in the quantity of inside money redistribute wealth. The central bank can control the interest rate and may improve welfare by adjusting it in response to aggregate shocks in order to mitigate the effects of price level increases on agents who have access only to their monetary savings. The effectiveness of this interest rate policy depends on the average inflation rate-in particular the policy becomes ineffective when the nominal interest rate is sufficiently low.

Asymmetric information and conversion price reset policy: The case of Chinese convertible debt

The Journal of Economic Asymmetries, 2015

This paper studies a firm's decision to reset the conversion price of convertible debt when the m... more This paper studies a firm's decision to reset the conversion price of convertible debt when the manager has asymmetric private information. Reset provisions are present uniquely in East Asian issues of convertible debt, and in practice allow a firm's management to lower the conversion price. We develop a signalling model in which a conversion price reset conveys unfavorable private information about the firm. This is because a firm will reset only if it cannot afford debt repayment. We conduct an event study with data on the equity prices of Chinese convertible bond issuing firms. We argue that conversion price resets exhibit negative announcement effects.

Bank money, asset prices and the financial liquidity channel of monetary policy

This paper extends the recent literature of "liquidity and asset prices" into monetary ... more This paper extends the recent literature of "liquidity and asset prices" into monetary models by adding money-creating banks. We explain why the money creation function of banks is important to financial stability. We study an economy in which not all assets can be used to make payments, agents may have to sell assets when they need cash. Sale of assets can lead to low asset price because buyers have limited ability to buy assets. Banks can provide liquidity by creating and lending out new deposit. This will reduce the sale of assets and stabilize asset prices. We also compare two types of liquidity provision mechanisms: liquidity-risk sharing through coalitions and liquidity provision through money creation. We show that if people use mutual-fund-like non-bank coalitions to share liquidity risks, then the function of banks to relax the aggregate money constraint is important. Without banks, non-bank coalitions will not be able to insure against aggregate liquidity risks, ...

Banks as dealers of credit money: Comparing the roles of banks and non-banks in the provision of liquidity

Using a general equilibrium monetary model for banks, we analyze the role of banks in providing l... more Using a general equilibrium monetary model for banks, we analyze the role of banks in providing liquidity to the financial market and the transmission of the financial liquidity channel of monetary policy. In the model, the roles of banks in the payment system give banks additional abilities to provide liquidity. Because bank deposits can be used as means of payment, banks can directly create and lend new deposits that are not backed by money collected from depositors. As a result, the private banking system has the ability to supply loans elastically to meet the stochastic liquidity needs of the economy with very little need to borrow from the central bank. We show that the existence of banks is important to non-banks. When aggregate liquidity is limited, the attempt of non-bank investment funds to provide more liquidity insurance to shareholders may lead to higher volatility in asset prices without actually giving more liquidity to shareholders. New inside money provided by banks ...

Bank money, aggregate liquidity, and asset prices

Annals of Economics and Finance

We build a general equilibrium model to analyze how the ability of banks to create money can affe... more We build a general equilibrium model to analyze how the ability of banks to create money can affect asset prices and financial stability. In the model, demand for liquidity takes the form of demand for money to make payments. We show that banks can provide elastic aggregate liquidity by creating and lending out deposits, which will reduce the need for people to sell assets and help maintain asset price stability. We also compare two types of liquidity provision mechanisms. The first is liquidity-risk-sharing through a Diamond-and-Dybvig style coalition that pools together people¡¯s resources, and the second is liquidity provision by banks though money creation. We show that without elastic aggregate liquidity provided by banks, coalitions can not actually perform their risk-sharing function, their attempt to sell assets to raise liquidity will only make asset prices decrease further, without actually raising more liquidity for shareholders hit by liquidity shocks. However, with bank...

Elastic Money, Inflation, And Interest Rate Policy

Optimal monetary policy is studied in an environment in which money plays an essential role in fa... more Optimal monetary policy is studied in an environment in which money plays an essential role in facilitating exchange and aggregate shocks affect individual agents asymmetrically. Exchange may be conducted using either bank deposits (inside money) or fiat currency (outside money). A central monetary authority both controls the stock of outside money and pursues an interest rate policy that affects the rate at which private banks create inside money. We find that the optimal monetary policy requires management of both interest rates and the quantity of outside money. By controlling interest rates the monetary authority can affect the price level in the short-run and adjust households' consumption, thus providing insurance against unfavorable aggregate shocks. The feasibility of the interest rate policy requires a minimum rate of trend inflation that may be positive and in principle quite large. The paper thus links two principal components of monetary policy: the optimal interest ...

Effect of Short-sale Constraints on Stock Price Manipulation

Pacific Economic Review, 2013

ABSTRACT This paper examines the effect of short‐sale constraints on the stock price manipulation... more ABSTRACT This paper examines the effect of short‐sale constraints on the stock price manipulation of an insider, who is subject to mandatory disclosure rules. We show that the privately informed insider may manipulate by trading against his or her information when short selling is banned. We find that stock price movement is asymmetric in the sense that prices fall by a larger percentage than they rise. In addition, we prove that removing short‐sale constraints increases price volatility. Finally, we explore the welfare implications of short‐sale constraints.

Influx endogne de capitaux spculatifs et sentier optimal d'apprciation de la monnaie

Abstract This paper examines the optimal appreciation path of an undervalued currency in the pres... more Abstract This paper examines the optimal appreciation path of an undervalued currency in the presence of speculative capital inflows that are endogenously affected by the appreciation path. A central bank decides its appreciation policy based on three costs: (i) misalignment costs associated with the gap between the actual and long-run equilibrium exchange rates, (ii) short-term adjustment costs due to resource reallocation, and (iii) capital losses due to speculative capital inflows. Our model finds (1) when speculators face no liquidity shocks, the central bank tends to appreciate the currency quickly to discourage speculative capital; (2) when speculators face liquidity shocks, the central bank optimally pre-commits to a slower appreciation path, and the appreciation takes the longest time when the probability of liquidity shocks takes intermediate values; (3) the central bank tends to appreciate the currency more quickly when it conducts discretionary policy. Ce mmoire examine l...

Elastic Money, Settlement, and Interest Rate Policy

by Junfeng Qiu and Allen Head

The transmission of monetary policy is studied in an environment in which aggregate liquidity sho... more The transmission of monetary policy is studied in an environment in which aggregate liquidity shocks affect agents asymmetrically. Agents are subject to random liquidity requirements and interact with banks which both take deposits and make loans. Banks may issue loans in excess of their deposits but face liquidity constraints due to settlement requirements which are satisfied using fiat money created by the central bank. The total money supply is determined endogenously by credit transactions. Changes in the overall money stock have different implications for prices and inflation depending on whether they are associated with growth in the supply of central bank issued (outside) money or with money creation by private banks (inside money). By affecting the price level, changes in the quantity of inside money redistribute wealth. The central bank can control the interest rate and may improve welfare by adjusting it in response to aggregate shocks in order to mitigate the effects of p...

Convertible bonds with resettable conversion prices

Economic Modelling, 2013

ABSTRACT We examine the convertible bonds whose conversion prices can be reset under certain cond... more ABSTRACT We examine the convertible bonds whose conversion prices can be reset under certain conditions, by extending the asymmetric information framework of Stein (1992). These convertibles are more common in Japan and China and are in sharp contrast with the convertible bonds with fixed conversion prices. We find that resettable convertibles can help firms reduce liquidity cost. But the adverse selection problem caused by bad firms may be exacerbated if the cost of financial distress is not sufficiently high. Firms can mitigate the problem through costly signaling with fixed-price convertibles. Finally, we show that pooling and separating equilibria may coexist for some parameter values.

Speculative capital inflows, adaptive expectations, and the optimal renminbi appreciation policy

China Economic Review, 2013

ABSTRACT This paper examines empirical evidence of the adaptive learning behavior of speculators ... more ABSTRACT This paper examines empirical evidence of the adaptive learning behavior of speculators in the 2005–2008 renminbi appreciation episode, and establishes a theoretical model to explore appreciation policy implications of such a behavior. In our model, speculators form their expectations about the future appreciation premium adaptively by extrapolating past appreciation returns into the future. We find that a rapid appreciation may attract more capital inflows, and the central bank may prefer a slow appreciation to discourage capital inflows. Simulated results can generate hump-shaped paths of the appreciation speed, expected appreciation premium, and capital inflows. In addition, changes in the appreciation speed precede changes in the expected appreciation premium and capital inflows. These results are consistent with empirical evidence in the 2005–2008 renminbi appreciation episode.

Endogenous inflows of speculative capital and the optimal currency appreciation path

Canadian Journal of Economics/Revue canadienne d'économique, 2011

This paper examines the optimal appreciation path of an undervalued currency in the presence of s... more This paper examines the optimal appreciation path of an undervalued currency in the presence of speculative capital inflows that are endogenously affected by the appreciation path. A central bank decides its appreciation policy based on three costs: (i) misalignment costs associated with the gap between the actual and long-run equilibrium exchange rates, (ii) short-term adjustment costs due to resource reallocation, and (iii) capital losses due to speculative capital inflows. Our model finds (1) when speculators face no liquidity shocks, the central bank tends to appreciate the currency quickly to discourage speculative capital; (2) when speculators face liquidity shocks, the central bank optimally pre-commits to a slower appreciation path, and the appreciation takes the longest time when the probability of liquidity shocks takes intermediate values;

Elastic money, inflation and interest rate policy

by Junfeng Qiu and Allen Head

We study optimal monetary policy in an environment in which money plays a basic role in facilitat... more We study optimal monetary policy in an environment in which money plays a basic role in facilitating exchange, aggregate shocks affect households asymmetrically and exchange may be conducted using either bank deposits (inside money) or fiat currency (outside money). A central bank controls the stock of outside money in the long-run and responds to shocks in the short-run using an interest rate policy that manages private banks' creation of inside money and influences households' consumption. The zero bound on nominal interest rates prevents the central bank from achieving efficiency in all states. Long-run inflation can improve welfare by mitigating the effect of this bound.