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Interbank Networks in the Shadows of the Federal Reserve Act

with Haelim Anderson, Guillermo Ordoñez
Revise and Resubmit, Review of Economic Studies , 2022
Elsevier Best Paper on Financial Institutions, Western Finance Association, 2020
The establishment of the Federal Reserve System (i) led to the emergence of the first shadow banking system, (ii) increased locally concentrated borrowing, and (iii) introduced new risks through reliance on short-term borrowing and public liquidity pass-through.

Central banks provide public liquidity (through lending facilities and promises of bailouts) with the intent to stabilize the financial system. Even though this provision is restricted to member (regulated) banks, an interbank system can provide indirect access to nonmember (shadow) banks. We construct a model to understand how a banking network may change in the presence of central bank interventions and how those changes affect financial fragility. We provide evidence showing that the introduction of the Fed’s liquidity provision in 1913 increased systemic risk through three channels; it reduced aggregate liquidity, created a new source of financial contagion, and crowded out private insurance for smoothing cross-regional liquidity shocks (manifested through the geographic concentration of networks).

Tor-Periphery Insider Networks

with Michael Junho Lee
Conditionally Accepted, Journal of Economic Theory , 2025
Effective regulation of insider trading necessitates regulatory ambiguity, as insiders can outcompete regulators by exploiting economies of scale, and outsourcing obfuscation and “gaming” to a centralized group that acts as conduits between tippers and tippees.

How do insiders respond to regulatory oversight on the use of insider information? History suggests that they form more sophisticated networks to circumvent regulation. We develop a theory of the formation and regulation of insider information networks. We show that agents with sufficiently complex networks bypass any given regulatory environment. In response, regulators employ broad regulatory boundaries to combat gaming. Tighter regulation induces agents to migrate activity from existing social networks to a tor-periphery network, a novel core-periphery network topology with a layered core of agents specialized in specific roles along transmission chains. A small group of agents endogenously arise as intermediaries for the bulk of transmissions.