Kuong, John
(2014)
Essays in financial economics.
PhD thesis, London School of Economics and Political Science.
Abstract
In this thesis, I study how information and asset market frictions can affect the investment and funding decisions of financial institutions, and their implications for the efficiency and stability of the financial system as a whole. The first chapter, Self-fulfilling fire sales, shows that while collateralised short-term debt mitigates individual borrowing firms’ incentives to take excessive risk, it also exerts pressure on the liquidity of the collateral asset market. When the asset market is not liquid enough, a vicious feedback loop between borrowers’ risk-taking incentives and expected asset fire-sale discount can cause instability in this secured funding market. Central bank intervention such as asset purchase is shown to be able to enhance stability and welfare. In the second chapter, Counter-cyclical foreclosure for securitisation, Jing Zeng and I study how information asymmetry in the mortgage securitisation process could distort the foreclosure policy of delinquent mortages. We show that banks would choose to commit to foreclose delinquent mortgages excessively in order to reduce the information friction in the securitisation process. This offers a potential explanation to the large number of foreclosures of delinquent mortgages in the U.S in the aftermath of the Subprime mortgage crisis in 2007-2009. The last chapter, Asset market
runs and the collapse of debt maturity, shows that when market-makers have limited riskabsorbing capacity and there is uncertainty in the execution prices of sell orders, a borrower may want to shorten the debt maturity in order to allow his creditor to demand repayment and liquidate the collateral asset ahead of creditors of other firms in the case of default. This strategic shortening of debt maturity in equilibrium amplifies the borrowers risk of
failing to roll-over their debt and leads to excessive asset liquidation.
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