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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
Theory and data suggest that 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).

Civil Liberties and Social Structure

with Camilo García-Jimeno
Revise and Resubmit, Journal of Economic Theory , 2023
Oppressive regimes that surveil societies to thwart potential threats while avoiding public backlash employ a “divide and conquer” strategy, discriminating against one (payoff-irrelevant) group and exploiting trust in another, even amidst evolving social structures.

Governments use coercion to aggregate distributed information relevant to governmental objectives –from the prosecution of regime-stability threats to terrorism or epidemics–. A cohesive social structure facilitates this task, as reliable information will often come from friends and acquaintances. A cohesive citizenry can more easily exercise collective action to resist such coercion, however. We present an equilibrium theory where this tension mediates the joint determination of social structure and civil liberties. We show that segregation and unequal treatment sustain each other as coordination failures: citizens choose to segregate along the lines of an arbitrary trait only when the government exercises unequal treatment as a function of the trait, and the government engages in unequal treatment only when citizens choose to segregate based on the trait. We characterize when unequal treatment against a minority or a majority can be sustained, and how equilibrium social cohesiveness and civil liberties respond to the arrival of widespread surveillance technologies, shocks to collective perceptions about the likelihood of threats or the importance of privacy, or to community norms such as codes of silence.

Insider Networks

with Michael Junho Lee
2nd Revise and Resubmit, Journal of Economic Theory , 2023
Effective regulation of insider trading necessitates regulatory ambiguity, as insiders can outcompete regulators by exploiting economies of scale, outsourcing obfuscation, and “gaming” strategies 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 core-periphery insider network. A small group of agents endogenously arise as intermediaries for the bulk of transmissions.