Adrien d´Avernas

This paper proposes a new model of monetary policy implementation to account for two key developments: (i) the introduction of intraday liquidity requirements and (ii) the decreasing relevance of the federal funds market in favor of repurchase agreement (repo) markets with nonbank participants. Our paper studies how liquidity requirements prevent banks from arbitraging between the fed funds and repo markets and generate large repo spikes. We propose a simple measure of excess intraday reserves. Consistent with our theory, this metric is close to zero in 2019Q2, when U.S. repo markets experienced a spike of 400 basis points.

We propose a model of post-Great Financial Crisis (GFC) money markets and monetary policy implementation. In our framework, capital regulation may deter banks from intermediating liquidity derived from holding reserves to shadow banks. Consequently, money markets can be segmented, and the scarcity of Treasury bills available to shadow banks is the main driver of short-term spreads. In this regime, open market operations have an inverse effect on net liquidity provision when swapping ample reserves for scarce T-bills or repos. Our model quantitatively accounts for post-2010 time series for repo rates, T-bill yields, and the Fed's reverse repo facility usage.

We provide a simple model of investment by a firm funded with debt and equity and empirical evidence to demonstrate that, once we control for the debt overhang problem with credit spreads, asset volatility is an unambiguously positive signal for investment, while equity volatility sends a mixed signal: Elevated volatility raises the option value of equity and increases investment for financially sound firms, but exacerbates debt overhang and decreases investment for firms close to default. Our study provides a simple unified understanding of the structural and empirical relationships between investment, credit spreads, equity versus asset volatility, leverage, and Tobin's .

Financial crises are particularly severe and lengthy when banks fail to recapitalize after bearing large losses. We present a model that explains the slow recovery of bank capital and economic activity. Banks provide intermediation in markets with information asymmetries. Large equity losses force banks to tighten intermediation, which exacerbates adverse selection. Adverse selection lowers bank profit margins, which slows both the internal growth of equity and equity injections. This mechanism generates financial crises characterized by persistent low growth. The lack of equity injections during crises is a coordination failure that is solved when the decision to recapitalize banks is centralized.

Banks’ ratio of the market value to book value of their equity was close to 1 until the 1990s, then more than doubled during the 1996-2007 period, and fell again to values close to 1 after the 2008 financial crisis. Some economists argue that the drop in banks’ market-to-book ratio since the crisis is due to a loss in bank franchise value or profitability. In this paper we argue that banks’ market-to-book ratio is the sum of two components: franchise value and the value of government guarantees.We empirically decompose the ratio between these two components and find that a large portion of the variation in this ratio over time is due to changes in the value of government guarantees.