Working Papers


Bong-Geun Choi



What is the Social Trade-Off from Securitization?
A Tale of Financial Innovation



This paper conducts a macroeconomic welfare analysis of securitization in a real business cycle (RBC) model with a banking sector. I model securitization as an interbank market funding option that credibly reduces the diversion ability on borrowed funds and increases operation costs on loan assets. In effect, securitization allows banks to increase the asset size while sacrificing per unit of asset return rate. I demonstrate that the availability of securitization increases the resilience against banking sector breakdowns and increases the size of credit booms associated with a breakdown. As a result, the economy experiences less frequent financial recessions but once a financial recession occurs, it is likely to be more severe. In the presence of the savings glut externality where households do not internalize the effects of their savings behavior on credit booms and banking sector breakdowns, the financial innovation of increasing the efficiency of securitization can make the social trade-off from securitization negative. This is because an abuse of securitization provides too much funding to the banking sector, causing an over-investment in production. Therefore, under highly developed securitization technology with minimal extra costs, regulation may be needed to balance the savings rate and the resilience against banking sector breakdowns. In a calibrated version of the model, I illustrate that an optimal regulation can make securitization socially beneficial.


Presented at CICF 2017, EconCon 2016, MIT-Chicago Joint Seminar for Macro-Finance Ph.D. students, Spring & Fall 2016 Midwest Macro Meetings, 2016 SEA Annual Meeting, University of Western Ontario, City University of Hong Kong, University of Tokyo, Peking University HSBC Business School, Northern Illinois University, Seoul National University, KAIST Business School, KDI, KCMI, KIEF and Bank of Korea



BongGeun Choi and Hyun Lee



Does Financial Innovation Increase Inequality?
A Competitive Search Approach



In this paper, we study the impact of financial innovation on wealth distribution and welfare, using a novel framework that embeds banking sector into the Aiyagari (1994) incomplete market heterogeneous agent model. The banking sector consists of the savings banks that have direct access to household savings but has no access to firms, and investment banks that can directly invest in firms but do not have direct access to household savings. Investment banks are heterogeneous in terms of their intermediation skills and their level of skills is private information. The interbank trading between the savings banks and the investment banks has a competitive search structure à la Guerrieri, Shimer, and Wright (2010), in which the savings banks can freely enter the interbank market by posting incentive compatible securities and bilaterally match with the investment banks. First, we show that our model endogenously generates three different rate of returns rates: the savings interest rate, the borrowing interest rate, and the rate of return on equity. Then, we calibrate and simulate our model to find two key results: 1) financial innovation that reduces the degree of adverse selection has the effect of reducing household wealth inequality; 2) financial innovation by “good” investment banks tend to increase wealth inequality.

Presented at Summer 2017 MFM Meeting for Young Scholars, Summer 2017 Econometric Society Meetings North America, Summer 2017 Econometric Society Meetings Europe, Summer 2017 Econometric Society Meetings Asia, Summer 2017 Econometric Society Meetings China, Tsinghua Workshop in Macroeconomics 2017, 2017 CEA Annual Meetings, 2017 KEA-APEA, Fall 2016 Midwest Macro Meetings

Work in Progress


BongGeun Choi and Harald Uhlig



Estimating DSGE Models with Risk Pricing Constraints:
A Higher Order Approach



When estimating DSGE models, it is useful to take into account information one learns about risk prices from financial markets such as excess equity returns, countercyclical risk premia or the shape of the term structure. This is important for many applications, including applications to monetary policy in particular, since the latter seeks to influence macroeconomic developments by influencing asset prices. Methodologically, this is often challenging, however, since the estimation procedure will be asked to fit both the macroeconomic dynamics as well as the asset price data, and may end up fitting the former better than the latter. In this paper, we therefore develop a procedure that allows the estimation of a DSGE model subject to the constraint that certain asset pricing restrictions hold. For example, this method allows the estimation of a DSGE model subject to the constraint that the estimated model delivers a given equity premium or delivers a given Sharpe ratio. Given that asset pricing equations often involve higher moments of the data, we pay particular attention to higher order approximations and their dynamics, in particular with respect to the asset pricing equations. This work extends the approach by Kliem and Uhlig (2014) by, in essence, extending the approach to incorporate higher-order approximations. These authors likewise have imposed constraints on asset pricing implications when estimating DSGE models, solving for the asset pricing implications per the second-order properties from the log-linearized, jointly normal dynamics. Like these authors, we shall impose the constraints in terms of a pre-imposed Bayesian "posterior" for the asset pricing implications. An extreme version of this is the imposition of an exact numerical value: so, in essence, we allow for the imposition of soft constraints. We apply this method to a baseline real business cycle model with habit formation as well as the well-studied Smets-Wouters model.



BongGeun Choi and Jin Yeub Kim



Dynamic Bargaining over Debt Covenants:
Renegotiation and Efficiency



In this paper, we consider a bargaining problem in which a borrower and a lender negotiate over covenants in debt contracts, using a mechanism design approach. In particular, we are interested in a dynamic setting where (i) the borrower is better informed than the lender about the firm's specific conditions and prospects, such as potential transfers from debt to equity; and (ii) the two players can jointly choose from among a variety of debt covenants with possibility of subsequent renegotiation. We show that informational incentives lead to the initial choice of covenants is ex-ante incentive inefficient. In ex-post renegotiation, the lender may waive covenants only with “successful” borrowers; and repeated such renegotiation schemes attain ex-ante incentive efficiency in equilibrium.


Bong-Geun CHOI


bgchoi@cityu.edu.hk | 852.6425.9274