Essays in Financial Economics

Abstract

This dissertation provides a theoretical study of bank and household capital structure and how they shape real allocations in the economy.

The first chapter presents a theory of bank capital structure based on a governance problem between the banker, outside equity investors, and households. The banker determines both the investment level in a project and its financing. A unique mix of equity capital and short-term debt maximizes the project's surplus for the investors. However, if the rents in banking are high and the banker's internal funding is scarce, the equilibrium features lower equity financing than the social optimum, implying a higher likelihood of bank runs and under-investment in the project. A minimum equity capital requirement simultaneously reduces the risk of bank runs and increases the investment level, while the banker is unambiguously worse-off.

The second chapter analyzes a portfolio problem with non-recourse debt. A risk-averse agent finances investment in a risky asset using a loan collateralized by the asset itself. The lenders offer her a competitive menu of interest rates and margin requirements. Her choice depends on her optimism about the asset values relative to the lenders, her risk aversion, and her wealth. The chapter uncovers a complementarity between the demand for the risky asset and the leverage ratio to finance this demand. A more optimistic agent buys a greater quantity of the risky asset, and is more levered. This co-movement result provides key insights into household debt: the mortgage loan-to-value ratio and the mortgage debt-to-income ratio should be pro-cyclical.

The third chapter introduces a general equilibrium framework of credit markets in which households and banks borrow and lend from each other. The equilibrium determines not only the interest rate and also two leverage ratios for the banks and the households. I find that a positive shock to asset values leads to a credit boom and higher household leverage, amplified by the general equilibrium effect of rising interest rates.