Abstract: Interest rate surprises measured around the Federal Open Market Committee announcements capture both surprises due to the central bank deviating from its usual stance and surprises due to the non-monetary central bank communication about the economic outlook. Looking at the response of financial markets in the Fed announcement window, I show that when stock prices fall in response to a positive interest rate surprise, firms reduce their investments, and financial frictions amplify this effect. Conversely, if stock prices increase in response to a positive interest rate surprise, firms accumulate more capital and financial frictions dampen investment. I show that a positive response of the financial markets to a tightening interest rate surprise is empirically consistent with an unexpected decrease in the risk premium in the capital markets, which in turn increases the price of debt and reduces the cost of financing capital investment. I develop a dynamic general equilibrium model with firm idiosyncratic productivity and real and financial frictions to explain the empirical findings and quantify the distributional effects of monetary policy on investment. The theoretical model also helps to explain recent findings in the literature.
Presented at: Boston College & Boston University Green Line Macro Meeting, Fall 2021
Strategic Behavior and Exchange Rate Dynamics (with Marco Errico) (New draft soon)
Abstract: The huge trading volumes in the foreign exchange rate markets are highly concentrated among a few financial players. The presence of large investors has been advocated for rejecting the assumption of perfectly competitive financial markets. We develop an international portfolio choice model with noise shocks and traders’ heterogeneity in market power. Large non-competitive traders internalize the impact of their portfolio decisions on determining prices. We find that higher market power i) amplifies (dampens) the response of the exchange rate to non-fundamental (fundamental) shocks; ii) destabilizes the exchange rate, increasing its volatility; iii) increases exchange rate predictability; iv) makes the exchange rate more disconnected to fundamentals. Our theoretical predictions are empirically confirmed on a cross-section of 18 currencies. Welfare analysis suggests that the consolidation in the financial sector in the last three decades increased investors’ welfare by 30%.
Presented at: Boston College & Boston University Green Line Macro Meeting, Spring 2020
Quarterly Earnings Mania, Markups and the Implications for Business Cycle (with Alessandro Lavia and Marco Errico) (Draft upon request)
Abstract: In the fast-paced business world of today, the relentless focus on short-term gains often takes precedence over long-term objectives distorting corporate choices. This paper investigates the impact of short-termism on markup dynamics and its ramifications for both corporate performance and business cycle fluctuations. In the data, firms meeting Wall Street earnings forecasts exhibit greater markup growth than those that miss the expectations. We interpret this empirical finding as an indication of the presence of short-term distortions in the variation of firms' markup levels. we construct a quantitative model of heterogeneous firms that incorporates idiosyncratic productivity, short-term frictions, and endogenous markup to examine the implications of these distortions on business cycle fluctuations.
Work in Progress
Firms' Balance Sheet Heterogeneity and Aggregate Fluctuations (with Simone Pesce and Marco Errico)
Unconventional Monetary Policy and Financial Frictions (with Fulvio Ferretti) (Draft upon request)