Publication
A Theory of Housing Demand Shock. (This version: May 2022) with Zheng Liu, Pengfei Wang and Tao Zha
- Journal of Economic Theory (2022).
- Abstract: Housing demand shocks in standard macroeconomic models are a primary source of house price fluctuations, but those models have difficulties in generating the observed large volatility of house prices relative to rents. We provide a microeconomic foundation for the reduced-form housing demand shocks with a tractable heterogenous-agent framework. In our model with heterogeneous beliefs, an expansion of credit supply raises housing demand of optimistic buyers and boosts house prices without affecting rents. A credit supply shock also leads to a positive correlation between house trading volumes and house prices. The theoretical mechanism and model predictions are supported by empirical evidence, and the results are robust to alternative specifications of heterogeneity.
Research Paper
Uncertainty, Corporate Diversification and Misallocation. (Job Market Paper) (This version: Dec 2023)
Turbulent Business Cycles. (slide) (This version: Aug 2023) with Zheng Liu and Pengfei Wang
Inflation Disagreement and the Transmission of Monetary Policy. (slide) (This version: Feb 2024) with Zheng Liu, Pengfei Wang and Min Wei
Financial Origins of Uncertainty. (slide) (This version: June 2023) with Zheng Liu and Pengfei Wang
- 2024 RES Scholars Fund
- 2023 ACEM Doctoral Forum Best Paper Award
- Presentations: 2024 RES Annual Conference; HKBU; SUSTech; SUFE; 2023 CBCF Annual Conference; Tsinghua; 2023 EWMES (Manchester); Fudan; CUHK; HKUST; Shanghai Jiaotong University; Peking University
- Abstract: In the environment of high uncertainty, corporations may choose to diversify their business. Using data on U.S. public firms at the segment and deal levels, I empirically document that 1) Firms expand their business scope in response to a rise in cross-sectional uncertainty, and high-productivity firms are more responsive; 2) Entry into a new business line in uncertain periods predicts lower growth, equity value and credit capacity; and 3) At the aggregate level, rising diversification following uncertainty shocks is associated with synchronized recession in aggregate activities and persistent decline in aggregate productivity. I explain these facts by building a heterogeneous-firm model with endogenous diversification and external financing constraint. In the model, a cross-sectional uncertainty shock prompts a diversification wave, which redistributes cash flow and credit away from high productivity sectors, leading to inefficient reallocation of resources and decline in aggregate TFP. The misallocation effect is amplified in competitive equilibrium where negative externality of diversification choice on other firms' value is not internalized. This novel channel enables a cross-sectional uncertainty shock to generate a recession with synchronized declines in aggregate activities, in line with empirical evidence.
Turbulent Business Cycles. (slide) (This version: Aug 2023) with Zheng Liu and Pengfei Wang
- Presentations: Stanford SITE 2022; ABFER 2022; SED 2022; CFRC 2023; CICF 2023; AMES 2023 (NTU); ESAM 2023(UNSW); ESEM 2023 (Spain); AMES 2022 (Shenzhen); CCER Summer Institute; Zhejiang University AFR; UConn; IMF; RES & SES 2023; CES China 2023; MMF 2023 (UK); PKU SOE; UTokyo; Fudan FISF; SJTU; CUHKSZ; HKU Macro Workshop; SETA 2024 (Taipei)
- Abstract: Recessions are associated with sharp increases in turbulence that reshuffle firms' productivity rankings. To study the business cycle implications of turbulence shocks, we use Compustat data to construct a measure of turbulence based on the (inverse of) Spearman correlations of firms' productivity rankings between adjacent years. We document evidence that turbulence rises in recessions, reallocating labor and capital from high- to low-productivity firms and reducing aggregate TFP and the stock market value of firms. A real business cycle model with heterogeneous firms and financial frictions can generate the observed macroeconomic and reallocation effects of turbulence. In the model, increased turbulence makes high-productivity firms less likely to remain productive, reducing their expected equity values and tightening their borrowing constraints relative to low-productivity firms. This leads to a reallocation that reduces aggregate TFP. Unlike uncertainty, turbulence changes both the conditional mean and the conditional variance of the firm productivity distribution, enabling a turbulence shock to generate a recession with synchronized declines in aggregate activities.
Inflation Disagreement and the Transmission of Monetary Policy. (slide) (This version: Feb 2024) with Zheng Liu, Pengfei Wang and Min Wei
- Presentations: Midwest Macro 2024 (Richmond); AMES 2024 (Hangzhou); HKUST CEP Brownbag; PHBS Sargent Institute Brownbag
- Abstract: Forecasters often disagree about inflation outlooks. We examine the implications of inflation disagreements for the transmission of monetary policy in a New Keynesian framework, generalized to incorporate heterogeneous beliefs about the central bank's inflation target. This tractable framework provides a microeconomic foundation for a discounted intertemporal Euler equation, mitigating the forward-guidance puzzle. The model implies that inflation disagreements weaken the macroeconomic effects of both forward guidance policy and the conventional interest rate policy. The model's mechanism and predictions are supported by empirical evidence.
Financial Origins of Uncertainty. (slide) (This version: June 2023) with Zheng Liu and Pengfei Wang
- Presentation: HKUST; PHBS
- Abstract: Countercyclical uncertainty could reflect exogenous shocks to uncertainty that drive business cycles. It could also reflect endogenous responses of measured uncertainty to other business cycle shocks. Evidence suggests that the cyclical behaviors of uncertainty depend on financial conditions, with tighter financial conditions associated with more countercyclical uncertainty. A real business cycle model with heterogeneous firms and endogenous default risks can explain these observations. In the model, productive firms face binding borrowing constraints. In a recession, an increase in default risks raises credit spreads, reducing the ex ante borrowing capacity for all firms. Since more productivity firms are more likely to be borrowing constrained, labor and capital are reallocated to firms with lower productivity, reducing aggregate productivity and deepening the recession. Thus, in a recession, a negative shock reduces aggregate output disproportionately more than a positive shock raises output in an expansion. Such state-dependent output responses lead to countercyclical uncertainty measured by the conditional variance of forecast errors. Under calibrated parameters, the model's quantitative predictions are in line with the data. The model also correctly predicts that uncertainty is more countercyclical under tighter financial constraints.
Selected Work in Progress
Information Friction, Asset Bubble and Business Fluctuations. with Zhaorui Li and Pengfei Wang
Idiosyncratic Volatility Puzzle Revisited with Speculation. with Kai Li, Zheng Liu and Pengfei Wang
Bubbly Premium. with Pengfei Wang and Jun Yu.
Idiosyncratic Volatility Puzzle Revisited with Speculation. with Kai Li, Zheng Liu and Pengfei Wang
Bubbly Premium. with Pengfei Wang and Jun Yu.
Conference Discussion
- Discussion slide on Real Credit Cycle by Pedro Bordalo, Nicola Gennaioli, Andrei Shleifer and Stephen J. Terry, at CICM (2022)
- Discussion slide on Endogenous Global Risks by Hao Hu and Ji Huang, at AFR (2022)
- Discussion slide on Inefficient Bubbly Boom by Feng Dong, Yang Jiao and Ninghao Sun, at Tshinghua SEM (2022)
- Discussion slide on Firm Balance-Sheet Channel of Uncertainty Shocks by Wentao Zhou, at AMES (2023)