Chapter 1 develops a general equilibrium model of firmover-borrowing with debt overhang, providing a novel angle for evaluating preventive policies during a corporate credit boom. When capital decisions must be made under idiosyncratic uncertainties, firms’ individually optimal investments ex-ante fail to internalize their effects on raising equilibrium asset price and overall indebtedness which, through debt overhang, squeezes borrowing capacity ex-post, weakens reallocation and depresses productivity. This pecuniary externality leads to a wedge between private and social costs of debt, thereby leaving room for regulations. Optimally set ex-ante interventions resolve the time consistency problem associated with ex-post stimulus, whereas restrictions on macroprudential measure create a...[ Read more ]

Chapter 1 develops a general equilibrium model of firmover-borrowing with debt overhang, providing a novel angle for evaluating preventive policies during a corporate credit boom. When capital decisions must be made under idiosyncratic uncertainties, firms’ individually optimal investments ex-ante fail to internalize their effects on raising equilibrium asset price and overall indebtedness which, through debt overhang, squeezes borrowing capacity ex-post, weakens reallocation and depresses productivity. This pecuniary externality leads to a wedge between private and social costs of debt, thereby leaving room for regulations. Optimally set ex-ante interventions resolve the time consistency problem associated with ex-post stimulus, whereas restrictions on macroprudential measure create a role for commitment. Subsidizing new debts reduces ex-ante incentive to borrow and thus is more desirable than bailing out existing ones. We then quantify the magnitude of inefficiency using an augmented industry dynamics model parameterized by a pan-European firm-level dataset. In the model, capital reallocation efficiency drops by 20% less in credit crunch if the economy ex-ante de-leverages to the constrained efficient level. In addition, the excessive accumulation of long-term debt during years of credit boom leads to declining capital reallocation efficiency not only in boom years but also in the credit bust that may follow.

Modern trade models attribute the dispersion of international prices to physical and man-made barriers to trade, to the pricing-to-market by heterogeneous producers and to differences in the quality of output offered by firms. Chapter 2 presents a general equilibrium model that incorporates all three of these mechanisms. Our model allows us to confront Chinese firm-level data on the prices charged and revenues earned across markets. We show that all three mechanisms are necessary to fit the distribution of prices and revenues across firms and markets. Accounting for endogenous quality heterogeneity across markets and firms is shown to be critical for the welfare implications of trade and for the response of prices to trade and tariff shocks.