Persuading the Principal To Wait
(Revise and Resubmit, Journal of Political Economy)
- Midwest Economic Theory (2016), North American Econometric Society (2016), SITE (2016), European Econometric Society (2016), FTG (2017)
We study strategic communication of verifiable information in a dynamic setting. The principal chooses when to exercise a real option. The agent affects the timing of option exercise by collecting and revealing additional information to the principal over time. When the agent favors late exercise relative to the principal and the conflict of interest is small, all information is disclosed discretely but with a delay. The principal exercises the option at the agent’s preferred threshold. When the conflict is large, the agent "pipets" information over time. Credible threat of option exercise is crucial for incentives to provide new information. When the agent favors early exercise, his lack of commitment not to persuade in the future leads to unraveling; in equilibrium all information is disclosed immediately. In sharp contrast to static environments, the ability to persuade might hurt the agent.
Design of Macro-prudential Stress Tests
- Rome Junior Finance (2017), Fed Stress Testing Research Conference (2017), Wharton Liquidity (2017)
We study the design of macro-prudential stress tests and liquidity requirements. The tests provide information about correlation in banks portfolios. The regulator chooses contingent liquidity requirements that create a buffer in case of a fire sale. The optimal stress test discloses information partially: when systemic risk is low, liquidity requirements reflect full information. When systemic risk is high, the regulator pools information and requires all banks to hold precautionary liquidity. With heterogeneous banks, weak banks determine level of transparency and strong banks are often required to hold excess liquidity when systemic risk is high. Moreover, dynamic disclosure and liquidity adjustments can improve welfare.
Dynamic Adverse Selection: Time Varying Market Conditions and Endogenous Entry
- SFS Cavalcade (2015), MIT Junior Finance (2015), WFA (2016)
- FTG Best Finance Theory Job Market Paper (2015)
In this paper I analyze the effect of time-varying market conditions and endogenous entry on equilibrium dynamics of markets plagued by adverse selection. I show that variation in gains from trade, stemming from market conditions, creates an option value and distorts liquidity when current gains from trade are low. An improvement in market conditions triggers a wave of high quality deals due to the preceding illiquidity and lack of incentives to signal quality. When gains from trade are high, the market is fully liquid; high prices and no delay in trade attract low-grade assets, and the average quality deteriorates. My analysis also reveals that illiquidity can act as a remedy as well as a cause of inefficiency: partial illiquidity allows for screening of assets and restores efficient entry incentives. I demonstrate model implications using several applications: early stage financing, initial public offerings, and private equity buyouts.
Optimal Issuance under Information Asymmetry and Accumulation of Cash Flows
- UNC-Duke Corporate Finance Conference (2013), FIRS (2014), AFA (2018)
We reexamine the classic yet static information asymmetry model of Myers and Majluf (1984) in a fully dynamic market. A firm has access to an investment project and can finance it by debt or equity. The market learns the quality of the firm over time by observing cash flows generated by the firm's assets in place. In the dynamic equilibrium, the firm optimally delays investment, but investment eventually takes place. In a "two-threshold" equilibrium, a high-quality firm invests only if the market's belief goes above an optimal upper threshold, while a low-quality firm invests if the market's belief goes above the upper threshold or below a lower threshold. However, a different "four-threshold" equilibrium can emerge if cash flows are sufficiently volatile. Relatively risky growth options are optimally financed with equity, whereas relatively safe projects are financed with debt, in line with stylized facts.
On the linear and nonlinear generalized Bayesian disorder problem (discrete time case)PDF
Optimality and Risk-Modern Trends in Mathematical Finance, pp. 227-236. Springer Berlin Heidelberg, 2010.
This paper considers a generalized Bayesian disorder (quickest detection) problem in discrete time with two types of penalty function — linear and non-linear ones. An explicit solution is given for the linear penalty function. Disorder problem is reduced to optimal stopping of multidimensional Markov process in case of non-linear penalty.
- FNCE250 - Venture Capital and the Finance of Innovation (2015-2017)
- This course covers the finance of technological innovation, with a focus on the valuation tools useful in the venture capital industry. These tools include the "venture capital method," comparables analysis, discounted cash flow analysis, contingent-claims analysis. The primary audience for this course is finance majors interested in careers in venture capital or in R&D-intensive companies in health care or information technology.
- Simon Business School, University of Rochester
- 305 Schlegel Hall, Rochester, NY 14627