Working Papers





  1. Convergence, Financial Development, and Policy Analysis, with Justin Yifu Lin and Pengfei Wang, PDF, May 2018


Abstract: We study the relationship among inflation, economic growth, and financial development in a Schumpeterian overlapping-generations model with credit constraints. In the baseline case money is super-neutral. When the financial development exceeds some critical level, the economy catches up and then converges to the growth rate of the world technology frontier. Otherwise, the economy converges to a poverty trap with a growth rate lower than the frontier and with inflation decreasing with the level of financial development. We then study efficient allocation and identify the sources of inefficiency in a market equilibrium. We show that a particular combination of monetary and fiscal policies can make a market equilibrium attain the efficient allocation.



  1. Macro-Financial Volatility under Dispersed Information, with Jieran Wu and Eric Young, PDF, October 2018.


Abstract: We provide a production-based asset pricing model under dispersed information. In the log-linearized equilibrium system, aggregate output and equity prices depend on the higher-order beliefs about average forecasts of aggregate demand and individual stochastic discount factors, respectively. We prove that the presence of dispersed information reduces aggregate output volatility under very general information structures, provided agents are informationally small. On the other hand, equity volatility can be arbitrarily high as the volatility of the idiosyncratic shock approaches infinity. We show our analytical results using the frequency-domain techniques. Under reasonable calibrations our model can match output and equity volatilities in the data.


  1. Asset Bubbles and Monetary Policy, with Pengfei Wang and Feng Dong, PDF, January 2017.


Abstract: We provide an infinite-horizon model of rational asset bubbles in a Dynamic New Keynesian framework. Entrepreneurs are heterogeneous in investment efficiency and face credit constraints. They can trade land as an asset, which also serves collateral to borrow from banks with reserve requirements. Land commands a liquidity premium and a land bubble can emerge. Monetary policy can affect the condition for the existence of a bubble, its steady-state size, and its dynamics including the initial size. The `leaning against the wind' interest rate policy will reduce the bubble volatility, but it may come at the cost of raising the inflation volatility. Whether monetary policy should respond to asset bubbles depends on the particular interest rate rule adopted by the central bank and on the exogenous shocks hitting the economy.


  1. Asset Bubbles and Foreign Interest Rate Shocks, with Pengfei Wang and Jing Zhou, PDF, November 2016


Abstract: We provide a DSGE model of a small open economy with both domestic and international financial market frictions. Firms face credit constraints and trade an intrinsically useless asset. Low foreign interest rates are conducive to bubble formation. An asset bubble provides liquidity and relaxes credit constraints. It provides a powerful amplification and propagation mechanism. Our estimated model based on Bayesian methods explains high volatilities of consumption and stock prices relative to output, countercyclical trade balance, and procyclical stock prices observed in the Mexican data over the period 1990Q1-2011Q4.


  1. Saving China’s Stock Market, with Yi Huang and Pengfei Wang, PDF, August 2016  VoxEU


Abstract: What are the economic benefits and costs of preventing a stock market meltdown during the summer of 2015 by the Chinese government intervention? We answer this question by estimating the value creation for the stocks purchased by the government between the period starting with the market crash in mid-June and the market recovery in September. We find that the government intervention increased the value of the rescued firms with a net benefit between RMB 2,464 and 3,402 billion, which is about 5% of the Chinese GDP in 2014. The value creation came from the increased stock demand by the government, the reduced default probabilities, and the increased liquidity.



  1. Oil Driven Stock Price Momentum, with Dayong Huang, PDF, May 2016


Abstract: Stocks with high exposure to oil price movements perform well when oil price rises and poorly when oil price falls. This oil driven stock price momentum differs from the conventional stock price momentum and it is related to firms’ profitability. Daily oil price movement measures the state of the economy at high frequency and exposures to oil price movement estimated with daily data can be significant in forecasting future returns.



  1. Dynamic Contracts with Learning Under Ambiguity, with Shaolin Ji and Li Li, PDF, March 2016.


Abstract: We study a continuous-time principal-agent problem with learning under ambiguity. The agent takes hidden actions to affect project output. The project quality is unknown to both the principal and the agent. The agent faces ambiguity about mean output, but the principal does not. We show that incentives are delayed due to ambiguity. While belief manipulation due to learning about unknown quality causes wages and pay-performance sensitivity to be front-loaded, ambiguity smooths wages and causes the drift and volatility of wages to decline more slowly over time. When the level of ambiguity is sufficiently large, the principal fully insures the agent by allowing the agent to shirk forever.




  1. Liquidity Premia, Price-Rent Dynamics, and Business Cycles, PDF, with Pengfei Wang and Tao Zha, February, 2014


Abstract: In the U.S. economy over the past twenty five years, house prices exhibit fluctuations considerably larger than house rents.  These price-rent dynamics tend to move together with business cycles and have a predictive power for house returns over the long horizon.  We develop and estimate a dynamic general equilibrium model to account for these facts and offer structural interpretations.  The model's transmission mechanism transforms a very small persistent shock to the stochastic discount factor into a large price-rent ratio fluctuation.  The same shock generates the comovement between the price-rent ratio and output.  Moreover, the rent-price ratio predicts the house return over the long horizon.



  1. Credit Risk and Business Cycles, with Pengfei Wang, PDF, August 2010.


Abstract: We incorporate long-term defaultable corporate bonds and credit risk in a dynamic stochastic general equilibrium business cycle model. Credit risk amplifies aggregate technology shocks. The debt-capital ratio provides a new state variable and its endogenous movements provide a propagation mechanism. The model can match the persistence and volatility of output growth as well as the mean equity premium and the mean risk-free rate as in the data. The model implied credit spreads are countercyclical and forecast future economic activities because they affect firm investment through Tobin's Q. They also forecast future stock returns through changes in the market price of risk. Finally, we show that shocks to the credit markets are transmitted to the real economy through Tobin's Q.



The following papers are outdated and need revisions. But they are still cited by a few papers.


1.      Stationary Equilibria of Economies with a Continuum of Heterogeneous Consumers, PDF, 2002


2.      Managerial Preferences,  Corporate Governance, and Financial Structure, PDF, with Hong Liu, March 2006


3.      Experimentation under Uninsurable Idiosyncratic Risk: An Application to Entrepreneurial Survival, PDF, with Neng Wang, May 2007


Abstract: We propose an analytically tractable continuous-time model of experimentation in which a risk-averse entrepreneur cannot fully diversify the idiosyncratic risk from his business investment. He makes consumption/savings and business exit decisions jointly, while learning about the unknown quality of the project over time. Using the closed-form solutions, we show that (i) the entrepreneur may stay in business even though the project's net present value (NPV) is negative; (ii) entrepreneurial risk aversion erodes option value and lowers private project value so that a sufficiently risk-averse entrepreneur may exit even when the NPV is positive; (iii) a more risk-averse or a more pessimistic entrepreneur exits earlier; and (iv) the model can generate a positive relation between wealth and entrepreneurial survival duration from undiversifiable idiosyncratic risk without liquidity constraints.


4.      Corporate Tax Policy and Long-Run Capital Formation: The Role of Irreversibility and Fixed Costs, PDF, May 2008.

Abstract: This paper presents an analytically tractable continuous-time general equilibrium model with investment irreversibility and fixed adjustment costs. In the model, there is a continuum of firms that are subject to idiosyncratic shocks to capital. Although the presence of investment frictions lowers consumer welfare, it may raise or reduce the long-run average capital stock, depending on the degree of idiosyncratic uncertainty. An increase in this uncertainty may raise equilibrium aggregate capital, but reduce welfare. An unexpected permanent change in the corporate income tax rate affects the investment trigger and target values, and hence the size and rate of capital adjustment. Following this tax policy, the percentage changes in equilibrium quantities are larger when fixed adjustment costs are larger. These changes are significantly smaller in a general equilibrium model than in a partial equilibrium model.