Using transaction level data for dwellings in Paris, France over the period 1986-92, we find evidence consistent with the hypothesis that economic fundamentals constrain movements in Parisian dwelling prices over longer term horizons. The conclusion is based on the results of two different procedures for estimating an error correction model of housing prices based on supply and demand fundamentals. The error correction models suggest that the speed of adjustment in the Paris dwelling market is about 30% per month. The paper also introduces a new econometric methodology that permits simultaneous estimation of the parameters of a dynamic hedonic price model, the price index, and the parameters of a structural model for housing prices. The new methodology is compared with the more traditional two-step procedure of first estimating a price index, and then using the estimated index in subsequent structural modeling.

This dissertation studies capital structure decisions of levered and unlevered firms using the modeling framework of Leland (1994). The first chapter, Cash Holdings and Financial Constraints, focuses on optimal management of cash holdings by equity holders of a levered, financially constrained firm. I add financial constraints as a market friction to the traditional model. A financially constrained firm is not able to issue new equity to subsidize net operating losses and is subject to premature, costly default on its straight debt. The more constrained the firm is the less equity it is able to issue and the more likely it is to default. Equity holders mitigate the effects of financial constraints by managing a costly cash account, based on retained net operating profits. In the theoretical section, I show that firms that are more financially constrained optimally hold more cash but remain more likely to default compared to their less constrained counterparts. Hence, firms with higher cash holdings are riskier, and claims on their assets should trade at a premium. In the empirical section, I find evidence of this observation in straight debt and common equity markets. Firms with higher cash holdings are observed with higher yields on debt and higher returns on equity,

In the second chapter, Contingent Capital Bonds (CCBs) and Capital Structure Decisions, a joint work with Dwight Jaffee and Alexei Tchistyi, we provide a formal model of CCBs, a new instrument offering potential value as a component of corporate capital structures for all types of firms, as well as being considered for the reform of prudential bank regulation following the financial crisis of 2007-2008. CCBs are debt instruments that automatically convert to equity if and when the issuing firm reaches a specified level of financial distress. We develop closed form solutions for CCB value under three assumptions. First, the firm is allowed a tax deduction on its CCB interest payments as long as the security remains outstanding as a bond. Second, we assume that adding CCBs to a firm's capital structure has no impact on the level of the firm's asset holdings. Third, we require that the CCB conversion to equity occurs at a time prior to any possible default by the firm on its straight debt. The key contribution of our work is that we provide a formal financial model in which the effects of alternative CCB contract provisions can be analytically evaluated. We show that a firm will always gain from including CCB in its capital structure as a result of the tax shield benefit. A firm creating a de novo capital structure, assuming it faces the regulatory constraint that the CCB can only replace a part of what would have been the optimal amount of straight debt, will always issue at least a small amount of CCB. The reduction in expected bankruptcy costs ensures a net gain, even if the tax shield benefits are reduced. We show that a firm will never add CCB to an existing capital structure, assuming that it faces the regulatory constraint that the CCB can only be introduced as part of a swap for a part of the outstanding straight debt. While the swap may increase the firm's value - the value of reduced bankruptcy costs may exceed any loss of tax shield benefits - the gain accrues only to the holders of the existing straight debt. As in a classic debt overhang problem, equity holders will not act to enhance the overall firm value. We show that for a Too-Big-To-Fail firm, for which the straight debt is risk free because the bond holders correctly assume they will protected from any potential insolvency, under a regulatory limitation on the amount of debt such a firm may issue, a CCB for straight debt swap reduces the value of the government subsidy by reducing the expected cost of bondholder bailouts. While this has a taxpayer benefit, the equity holders of such a firm would not voluntarily participate in such a swap. We demonstrate that CCBs create an incentive for market manipulation. CCB holders may have an incentive to manipulate the stock price to a lower value if the amount of equity they receive at conversion is sufficiently high. Equity holders may have an incentive to manipulate the stock price down if the amount of equity they give up at conversion is sufficiently low. We summarize, that the regulatory benefits of CCB issuance with respect to bank safety will generally depend on the CCB contract and issuance terms. Perhaps most importantly, the regulatory benefits vanish if banks simply substitute CCBs for capital, leaving the amount of straight debt

unchanged. It is thus essential to require CCB issuance to substitute for straight debt (and not for equity).

This paper considers the effects of agglomeration on the production decisions of firms in the high-tech computer cluster. We build upon an alternative definition of the high-tech computer cluster developed by Bardhan et al. (2003) and we exploit a new data source, the National Establishment Time-Series (NETS) Database, to analyze the spatial distribution of firms in this industry. An essential contribution of this research is the recognition that high-tech firms are heterogeneous collections of establishments. We explicitly model the kinship relationships between the headquarters and establishments of these firms and account for their endogenous production technology choices using controls for the spatial and functional configurations of each firm’s establishment locations. The empirical results, from our preferred specification of a random parameters restricted maximum likelihood (REML) production function, are broadly consistent with several recent theoretical models of supply chain management under incomplete contracting (Combes and Duranton (2003), Almazan et al. (2003), and Rotemberg and Saloner (2000)). We find statistically significant and economically meaningful localization effects on high-tech firms’ labor input technology arising from MSA-level proximity to workers in computer services Standard Industrial Classifications (SICs) and establishment-level geographic interactivity. We also find that localization effects have economically significant impacts on the elasticities of other purchased inputs. The channels for these effects are again access to large computer services labor markets and geographically dispersed networks of establishments. Our empirical results indicate that there are few benefits associated with firm locations in labor markets with large numbers of employees in the computer manufacturing sectors. This negative result may reflect the culmination of recent trends in out-sourcing manufactured inputs to distant offshore subsidiaries. Finally, we uncover considerable heterogeneity in the production technologies exploited by firms in the high-tech computer cluster, although in general, the production technology of this industry is characterized by constant returns to scale.

Current pricing of ABX.HE indexed credit default swaps (CDS) imply levels of forecasted losses for sup-prime residential mortgage backed securities (RMBS) that are substantially greater than realized credit events in these securities. Regression results, controlling for the correlational structure of the common underlying mortgage pools, indicate that the credit performance of the referenced sub-prime RMBS is uncorrelated with observed fluctuations in the ABX.HE indexed CDS returns. Although we find some evidence that volatility shocks, as measured by VIX, have also negatively impacted ABX.HE returns, these effects are not consistently associated with devaluations on higher credit rated ABX.HE indexed CDS. Instead, the returns on ABX.HE indexes of all credit qualities are consistently and statistically significantly related to short-sale demand imbalances in the option and equity markets of the publicly-traded builders, the commercial banks, the investment banks and the government sponsored enterprises (GSEs). The combined effect of the unique settlement structure of the ABX.HE indexes, the lower short sales constraints in the indexed credit default swap market, and the important supply limitations in the cash market for BBB and BBBtranches appear to have significantly amplified arbitrage imbalances between the cash market for tranches and the ABX.HE indexed derivatives. Our results indicate that dislocations associated with aggregate short-selling imbalances in the mortgage related capital markets rather than credit events in the outstanding stock of sub-prime RMBS, per se appear to be central to the substantial price devaluations of the ABX.HE indexed credit default swaps. Our finding that the short-selling strategies of arbitrageurs have exacerbated the effects of negative economic shocks in the sub-prime RMBS market leads us to conclude that the ABX.HE indexed CDS are imperfect benchmarks for marking-to-market mortgage portfolios because the indexed market does not efficiently aggregate information concerning the credit performance of referenced sub-prime mortgage obligations.

Mortgage-backed securities, with their relative structural simplicity and their lack of recovery rate uncertainty if default occurs, are particularly suitable for developing and testing risky debt valuation models. In this paper, we develop a two-factor structural mortgage pricing model in which rational mortgage-holders endogenously choose when to prepay and default subject to i. explicit frictions (transaction costs) payable when terminating their mortgages, ii. exogenous background terminations, and iii. a credit related impact of the loan-to-value ratio (LTV) on prepayment. We estimate the model using pool-level mortgage termination data for Freddie Mac Participation Certificates, and find that the effect of the house price factor on the results is both statistically and economically significant. Out-of-sample estimates of MBS prices produce option adjusted spreads of between 5 and 25 basis points, well within quoted values for these securities.

U.S. buildings consume almost 39% of the total U.S. energy usage, and appear inefficient compared to the available technology and the efficiency of European structures. Government building codes, disclosure requirements, and fiscal subsidies have been the primary instruments used to stimulate the adoption of energy-efficient technology, but have significant limitations. In this paper, we instead look at market mechanisms to stimulate voluntary private sector energy-efficient investments. We argue that the failure of commercial mortgage lenders to take energy-efficiency into account is primarily the result of insufficient information to connect high and volatile energy prices to mortgage default. As a first step in rectifying this failing, we use a Monte Carlo methodology, based on stochastic energy prices, to provide quantitative measures—both expected values and the range of variability—of the impact of energy prices on measures of possible mortgage default.

This dissertation consists of two chapters that concern financial intermediation. Many shadow banks rely heavily on bank-sponsored private credit and liquidity support instead of government guarantees. Bank capital regulation cannot be effective without explicitly considering these facilities. In the first chapter of the dissertation, I use a continuous time model with maturity mismatch and bank moral hazard to study the impact of credit and liquidity guarantees on bank capital structure. I focus on a particular type of shadow banking called asset-backed commercial paper (ABCP). When banks provide credit guarantees to ABCP conduits, assuming that the validity of the guarantees is ensured by rating agencies, the commercial paper becomes risk free and is always priced at par. Rolling over the commercial paper is thus costless, so that frequently rolling over the short term ABCP to fund long term assets---a maturity mismatch---has no impact on bank value. Regulators can eliminate a bank's moral hazard by imposing a simple capital ratio requirement. However, the capital ratio requirement is no longer valid if banks use liquidity guarantees in their ABCP conduit funding because the funding maturity becomes important. Moreover, a liquidity guarantee becomes as costly as a credit guarantee when the maturity shortens. Using Moody's ABCP conduit data, I confirm that shorter ABCP maturity causes the bank's return to be more sensitive to the conduit credit loss. Thus, when banks have significant exposure to a liquidity guarantee, the search for a single appropriate risk weight is futile. More sophisticated tests, such as model-based tests are not only necessary but also have to be carried out under stressed scenarios.

The second chapter studies the current London Interbank Offered Rate (LIBOR). Recent investigation reveals banks might have manipulated the London Interbank Offer Rate (LIBOR). With banks concern about derivative position, net interest income and signaling effect, the equilibrium reporting strategy is a monotonic non-linear function of borrowing cost. Current trimming mechanism cannot block tacit collusion: when banks benefit from lower LIBOR, tacit collusion leads to downward biased LIBOR quotes. Signaling effect causes further depressed LIBOR. Equilibrium submissions do cluster together, as people have observed from the data. Comparative statics suggest LIBOR bias spikes during the crisis, due to more dispersed borrowing costs and consumers' less confidence in banks. I propose a direct and \emph{ex ante} budget balanced LIBOR fixing mechanism. Finally, by calibrating the model to the ratio of dispersion among banks' LIBOR submissions to their CDS spreads, I come up with an initial estimation, which matches practitioner's opinions back in 2008, about LIBOR bias during the recent crisis.

This dissertation consists of two chapters that concern with the consumption cycle and corporate finance. The first chapter analyzes the role of durability in characterizing the consumption cycle. There is strong empirical evidence demonstrating that decreases in residential investments and durable expenditures are early indicators of economic downturns. Analogously, once the economy goes into recession, early increases in residential investments and durable expenditures signal economic recoveries. So far, little work has been done detailing the mechanisms explaining these important empirical stylized facts. In this article, I develop a general equilibrium asset pricing production model that includes durability and substitutability between perishable and durable service consumption. Results indicate that large shocks in the productivity of the capital accumulation process and a high elasticity of intertemporal substitution are both needed to create the correct timing of changes in durable expenditures and nondurable consumption characterized in the data. The study also uses this general equilibrium model as a framework to make predictions about the term structure of forward contracts settled on a national housing price index. Such work will create a foundation for further developing this important derivatives market.

The second chapter analyzes the link between debt maturity and the term spread. This chapter is co-authored with Pratish Anilkumar Patel. Evidence shows that a firm's debt maturity and term spread are intricately linked. Firms issue short term debt when the term spread is significantly positive and they increase maturity as the term spread decreases. The current literature explains this link with market frictions such as agency problems, asymmetric information, and liquidity risk. We explain the link between debt maturity and term spread using the trade-off theory of capital structure. When the term spread is small or even negative, transaction costs of debt rollover outweigh bankruptcy costs. Therefore, the firm optimally chooses to increase debt maturity. On the other hand, when the term spread is significantly positive, bankruptcy costs outweigh transaction costs of debt rollover. Therefore shorter debt maturity is optimal as it minimizes the chance of bankruptcy. In addition, we contribute to the current discussion in the literature concerning the speed of adjustments of capital structure, finding that firms are active in adjusting their capital structure. The model is consistent with a variety of stylized facts concerning debt maturity.