Dmitry Orlov

Bio: Dmitry Orlov is an academic researcher from University of Wisconsin-Madison. The author has contributed to research in topics: Market liquidity & Systemic risk. The author has an hindex of 7, co-authored 12 publications receiving 626 citations. Previous affiliations of Dmitry Orlov include University of Rochester.

Sizing Up Repo

Abstract: We measure the repo funding extended by money market funds (MMF) and securities lenders to the shadow banking system, including quantities, haircuts, and repo rates by type of underlying collateral We find that repo played only a small role in funding private sector assets prior to the crisis, as most repos are backed by Treasury and Agency collateral Repo with private sector collateral contracts during the crisis, but the magnitude is relatively insignificant compared with the contraction in asset-backed commercial paper (ABCP) While relatively small in aggregate, the contraction in repo particularly affected key dealer banks with large exposures to private sector securities, which then had knock-on effects on security markets, and led these dealer banks to resort to the Fed's emergency lending programs We also find that haircuts in MMF-to-dealer repo rise less than the dealer-to-dealer or dealer-to-hedge fund repo haircuts reported in earlier papers This finding suggests that the contraction in repo led dealers to take defensive actions, given their own capital and liquidity problems, raising credit terms to their borrowers The picture that emerges from these findings looks less like a traditional bank run of depositors and more like a credit crunch among dealer banks

Sizing Up Repo

Abstract: To understand which short-term debt markets experienced �runs� during the financial crisis, we analyze a novel data set of repurchase agreements (repo), that is, loans between nonbank cash lenders and dealer banks collateralized with securities. Consistent with a run, repo volume backed by private asset-backed securities falls to near zero in the crisis. However, the reduction is only $182 billion, which is small relative to the stock of private asset-backed securities as well as the contraction in asset-backed commercial paper. While the repo contraction is small in aggregate, it disproportionately affected a few dealer banks.

Sizing Up Repo

Abstract: We measure the repo funding extended by money market funds (MMF) and securities lenders to the shadow banking system, including quantities, haircuts, and repo rates by type of underlying collateral. We find that repo played only a small role in funding private sector assets prior to the crisis, as most repos are backed by Treasury and Agency collateral. Repo with private sector collateral contracts during the crisis, but the magnitude is relatively insignificant compared with the contraction in asset-backed commercial paper (ABCP). While relatively small in aggregate, the contraction in repo particularly affected key dealer banks with large exposures to private sector securities, which then had knock-on effects on security markets, and led these dealer banks to resort to the Fed's emergency lending programs. We also find that haircuts in MMF-to-dealer repo rise less than the dealer-to-dealer or dealer-to-hedge fund repo haircuts reported in earlier papers. This finding suggests that the contraction in repo led dealers to take defensive actions, given their own capital and liquidity problems, raising credit terms to their borrowers. The picture that emerges from these findings looks less like a traditional bank run of depositors and more like a credit crunch among dealer banks.

Design of Macro-Prudential Stress Tests

Abstract: We study the design of macro-prudential stress tests and capital requirements The tests provide information about correlation in banks portfolios The regulator chooses contingent capital requirements that create a liquidity buffer in case of a fire sale The optimal stress test discloses information partially: when systemic risk is low, capital requirements reflect full information When systemic risk is high, the regulator pools information and requires all banks to hold precautionary liquidity With heterogeneous banks, weak banks determine level of transparency and strong banks are often required to hold excess capital when systemic risk is high Moreover, dynamic disclosure and capital adjustments can improve welfare

Persuading the Principal to Wait

Abstract: A principal decides when to exercise a real option. A biased agent influences this decision by strategically disclosing information. Committing to disclose all information with a delay is the optim...

The Optimal Allocation of Prizes in Contests

Abstract: We study a contest with multiple (not necessarily equal) prizes. Contestants have private information about an ability parameter that affects their costs of bidding. The contestant with the highest bid wins the first prize, the contestant with the second-highest bid wins the second prize, and so on until all the prizes are allocated. All contestants incur their respective costs of bidding. The contest's designer maximizes the expected sum of bids. Our main results are: 1) We display bidding equlibria for any number of contestants having linear, convex or concave cost functions, and for any distribution of abilities. 2) If the cost functions are linear or concave, then, no matter what the distribution of abilities is, it is optimal for the designer to allocate the entire prize sum to a single ''first'' prize. 3) We give a necessary and sufficient conditions ensuring that several prizes are optimal if contestants have a convex cost function.

Fallacies, Irrelevant Facts, and Myths in the Discussion of Capital Regulation: Why Bank Equity is Not Expensive

Abstract: We examine the pervasive view that "equity is expensive," which leads to claims that high capital requirements are costly for society and would affect credit markets adversely We find that arguments made to support this view are fallacious, irrelevant to the policy debate by confusing private and social costs, or very weak For example, the return on equity contains a risk premium that must go down if banks have more equity It is thus incorrect to assume that the required return on equity remains fixed as capital requirements increase It is also incorrect to translate higher taxes paid by banks to a social cost Policies that subsidize debt and indirectly penalize equity through taxes and implicit guarantees are distortive And while debt’s informational insensitivity may provide valuable liquidity, increased capital (and reduced leverage) can enhance this benefit Finally, suggestions that high leverage serves a necessary disciplining role are based on inadequate theory lacking empirical support We conclude that bank equity is not socially expensive, and that high leverage at the levels allowed, for example, by the Basel III agreement is not necessary for banks to perform all their socially valuable functions and likely makes banking inefficient Better capitalized banks suffer fewer distortions in lending decisions and would perform better The fact that banks choose high leverage does not imply that this is socially optimal Except for government subsidies and viewed from an ex ante perspective, high leverage may not even be privately optimal for banks Setting equity requirements significantly higher than the levels currently proposed would entail large social benefits and minimal, if any, social costs Approaches based on equity dominate alternatives, including contingent capital To achieve better capitalization quickly and efficiently and prevent disruption to lending, regulators must actively control equity payouts and issuance If remaining challenges are addressed, capital regulation can be a powerful tool for enhancing the role of banks in the economy

Banking, Liquidity and Bank Runs in an Infinite-Horizon Economy

Abstract: We develop a variation of the macroeconomic model of banking in Gertler and Kiyotaki (2011) that allows for liquidity mismatch and bank runs as in Diamond and Dybvig (1983). As in Gertler and Kiyotaki, because bank net worth ‡uctuates with aggregate production, the spread between the expected rates of return on bank assets and deposits ‡uctuates countercyclically. However, because bank assets are less liquid than deposits, bank runs are possible as in Diamond and Dybvig. Whether a bank run equilibrium exists depends on bank balance sheets and an endogenous liquidation price for bank assets. While in normal times a bank run equilibrium may not exist, the

A Model of Shadow Banking

Abstract: We present a model of shadow banking in which banks originate and trade loans, assemble them into diversified portfolios, and finance these portfolios externally with riskless debt. In this model: outside investor wealth drives the demand for riskless debt and indirectly for securitization, bank assets and leverage move together, banks become interconnected through markets, and banks increase their exposure to systematic risk as they reduce idiosyncratic risk through diversification. The shadow banking system is stable and welfare improving under rational expectations, but vulnerable to crises and liquidity dry-ups when investors neglect tail risks. SHADOW BANKING TYPICALLY DESCRIBES financial activities occurring outside the regulated banking sector. In recent years, the most important such activities took the form of rapidly expanding provision of short-term safe debt to financial intermediaries through money market funds and other sources outside of the regulated banking sector (Coval, Jurek, and Stafford (2009a), Gorton and Metrick (2010, 2012), Pozsar et al. (2010), Shin (2009)). Much of that debt was collateralized through the process called securitization, which involves origination and acquisition of loans by financial intermediaries, the assembly of these loans into diversified pools, and the tranching of the pools to manufacture safe pieces. While regulated banks played a key role in securitization and held large amounts of securitized assets, a large share of the ultimate financing of securitized assets was provided by the shadow banking system. The collapse of shadow banking in 2007 to 2008 arguably played a critical role in undermining the regulated banking sector, and in bringing about the financial crisis. In this paper, we present a new model of shadow banking and securitization. In the model, a financial intermediary can originate or acquire both safe and risky loans, and can finance these loans from its own resources as well as by issuing debt. The risky loans are subject to both institution-specific idiosyncratic