"A Quantitative Theory of Information and Unsecured Credit" with Kartik Athreya and Xuan S. Tam. Over the past three decades five striking features of aggregates in the unsecured credit market have been documented: (1) rising availability of credit along both the intensive and extensive margins, (2) rising debt accumulation, (3) rising bankruptcy rates and discharge in bankruptcy, (4) rising dispersion in interest rates across households, and (5) the emergence of a discount for borrowers with good credit ratings. We show that all five outcomes are quantitatively consistent with improvements in the ability of lenders to observe borrower characteristics. Part of our contribution is the development of an algorithm for computing equilibria with asymmetric information and individualized pricing. From a welfare perspective, our main finding is that more information is better ex ante, even though better information can rule out pooling outcomes that some groups might find beneficial ex post. Federal Reserve Bank of Richmond Working Paper No 08-6.
"Information Heterogeneity in the Macroeconomy" with Ponpoje Porapakkarm. This paper considers the role that information heterogeneity can play in generating wealth inequality. We solve a model where households face both aggregate and idiosyncratic shocks to returns and wages under two assumptions about information – fully-informed (FI) economies have agents who observe all states while partially-informed (PI) economies have agents that must rely on the Kalman filter to extract estimates of the states based on observed prices. We find that the PI economy has higher aggregate activity (output, consumption, investment) and larger fluctuations in output and investment. Quantitatively, we find that the most important factor is the gap between the PI agents’ beliefs about the state of the world today and the true state; the other two factors, the heterogeneity of forecasts tomorrow and the higher risk faced by PI agents, generate only small changes in behavior.
Programs for FI Economy and PI Economy
"A Note on Sunspots with Heterogeneous Agents" with Daniel R. Carroll. This paper studies sunspot fluctuations in a model with heterogeneous households. We find that wealth inequality reduces the degree of increasing returns needed to produce indeterminacy, while wage inequality increases it. When the model is calibrated to match the joint distribution of hours, income, and wealth the required degree of increasing returns to scale is still much too high to be supported empirically (although smaller than similar homogeneous agent economies). We also find that the model robustly predicts only one sunspot, despite having 1242 predetermined state variables. Federal Reserve Bank of Cleveland Working Paper No 09-06.
"Asset Pricing under Information-Processing Constraints" with Yulei Luo. This note shows that limited information processing has the potential to increase the equity premium because it introduces persistence and excess volatility into consumption growth.
"Are Harsh Penalties for Default Really Better?" with Kartik Athreya and Xuan S. Tam. How might society ensure the allocation of credit to those who lack meaningful collateral? Two very different options that have each been pursued by a variety of societies through time and space are (i) relatively harsh penalties for default and more recently (ii) loan guarantee programs which allow borrowers to default subject to moderate consequences and use public funds to compensate lenders. The goal of this paper is to provide a quantitative statement about the relative desirability of these responses. Our findings are twofold. First, we show that under a wide array of circumstances, punishments harsh enough to ensure all debt is repayed improve welfare. With respect to loan guarantees, our findings suggest that such efforts are largely useless at best, and substantially harmful at worst. Generous loan guarantees virtually ensure substantially higher taxes -- with transfers away from the non-defaulting poor to the defaulting middle-class -- and greater deadweight loss from high equilibrium default rates. Taken as a whole, our findings suggest that current policy towards default is likely to be counterproductive, and that guarantees for consumption loans are not the answer. Federal Reserve Bank of Richmond Working Paper No 09-11.