We study how firm heterogeneity determines liquidity in over-the-counter markets. Using a rich dataset on trading in the secondary market for sterling corporate bonds, we build and estimate a flexible model of search and trading in which firms have heterogeneous search costs. We show that the 8% most active traders supply as much liquidity as the remaining 92%. Liquidity is thus vulnerable to shocks to these firms: if the 4% most active traders stop trading, liquidity falls by over 60%. Bank capital regulation reduces the willingness of these active traders to hold assets and thus reduces liquidity. However, trader search, holdings and intermediation respond endogenously to reduce the welfare costs of regulation by 30%. These costs are greater in a stress, when these margins of adjustment are constrained. The introduction of trading platforms, which homogenise the ability of traders to trade frequently, improves aggregate welfare but harms the most active traders who currently profit from supplying liquidity.

Download the paper

A structural model of interbank network formation and contagion, with Patrick Coen (Toulouse School of Economics)

The interbank network, in which banks compete with each other to supply and demand financial products, creates surplus but may also result in risk propagation. We examine this trade-off by setting out a model in which banks form interbank network links endogenously, taking into account the effect of links on default risk. We estimate this model based on novel, granular data on aggregate exposures between banks. We find that the decentralised interbank network is not efficient, primarily because banks do not fully internalise a network externality in which their interbank links affect the default risk of other banks. A social planner would be able to increase surplus on the interbank network by 13% without increasing mean bank default risk or decrease mean bank default risk by 4% without decreasing interbank surplus. We propose two novel regulatory interventions (caps on aggregate exposures and pairwise capital requirements) that result in efficiency gains.

Download the paper

Price discrimination and mortgage choice, with Anil Kashyap (Chicago Booth) and May Rostom (Bank of England)

We characterize the large number of mortgage offers for which people qualify. Almost no one picks the cheapest option, nonetheless the one selected is not usually much more expensive. A few borrowers make very expensive choices. These big mistakes are most common when the menu they face has many expensive options, and are most likely for high loan-to-value and loan-to-income borrowers. Young people and first-time buyers are more mistake-prone. The dispersion in the mortgage menu is consistent with banks attempting to price discriminate for some borrowers who might pick poorly while competing for others who might shop more effectively.

Download the paper

Placement Officer
Professor Mark Schankerman

Supervisor
Professor Alessandro Gavazza

References
Professor Alessandro Gavazza
Professor Anil Kashyap
Professor Dimitri Vayanos

Email
w.j.coen@lse.ac.uk

Office Address
Department of Economics,
London School of Economics and Political Science,
Houghton Street, London WC2A 2AE