Research
Working Papers
A Macro-Finance Model of Credit Spreads
with Theofanis Papamichalis, Dimitrios P. Tsomocos, and Nikolaos Romanidis
Presentation: SAET 2025
Abstract:
We argue that fluctuations in corporate credit spreads arise from the time-varying risk-bearing capacity of financial intermediaries. Empirically, we show that the primary broker dealers’ leverage ratios closely tracks the excess bond premium, highlighting that intermediary balance sheets, rather than firm-level default fundamentals, drive the dominant component of spreads. Guided by this evidence, we build a continuous-time heterogeneous-agent model in which productive experts finance capital with defaultable debt subject to an equity constraint and an endogenous, non-pecuniary default penalty. Three results obtain. (i) The model resolves the credit-spread puzzle: even after conditioning on expected default losses, equilibrium spreads include a sizable wedge that varies with intermediary net worth. (ii) Default is non-neutral: higher default rates raise the user cost of capital, depress investment, and amplify aggregate volatility. (iii) Default penalties have a non-monotonic welfare effect: lax penalties induce excessive leverage ex ante, whereas stringent penalties accelerate fire-sale deleveraging ex post. We characterise optimal policy by solving for the social planner’s solution to pin down an interior default penalty schedule.
Our Deficit, Your Problem: Fiscal Sustainability and Exchange Rates
with Tobias Kawalec
Presentations: Austrian National Bank; University of Konstanz; LSE Macro PhD Workshop
Abstract:
We develop and estimate an open-economy present-value framework for the government budget constraint that embeds discount factors, exchange-rate expectations, and time-varying foreign-exchange risk premia. Using newly constructed market-value data for U.K. and U.S. public debt covering 1975-2024, we document that unexpected changes in the debt ratio are split equally between revisions to expected future surpluses and discount-rate news; the latter reflects movements in global real yields, revisions to expected real exchange rates, and UIP-premium shocks. Surplus innovations recovered from market prices is shown to materially affect the bilateral real exchange rate. We then present a tractable two-country model in which fiscal shocks in a financial hegemon propagate internationally through exchange-rate adjustments that feed back into real interest rates; the model rationalises the empirical shares and predicts “fiscal contagion” across sovereign balance sheets. A continuous-time general equilibrium framework further shows how exchange rate movements can be induced by changes to relative surpluses and debt issuances.
The Inequality Multiplier: Market Inelasticity and the Persistence of Wealth Inequality
with Aditya Khemka
Presentations: Bank of England Macro Brown Bag; Asian Finance Association, Taipei; Trans-Atlantic Doctoral Conference, London Business School; Rethinking Economic Theory Conference, Athens
Winner of Best Doctoral Paper at Saïd Business School, 2024
Abstract:
We study how recent changes in U.S. equity market macrostructure shape market capitalization, aggregate debt levels, and wealth inequality. Rising income inequality, combined with inelastic markets, drives persistent wealth disparities through asset price revaluation—a mechanism we term the “inequality multiplier.” Using a general equilibrium model, we identify two channels: (i) the equity investment channel, where wealthy households’ higher propensity to save amplifies equity price booms; and (ii) the borrowing channel, where increased indebtedness raises equity prices via rebalancing demand from financial intermediaries. Calibrating the model to U.S. data, we show that this multiplier makes wealth inequality self-perpetuating and drives a growing wedge between income and wealth inequality. The model replicates observed trends in equity prices, debt levels, and wealth concentration, revealing how asset market frictions drive inequality beyond existing explanations in the literature. The equity investment channel shapes long-run trends, while the borrowing channel explains short-run cycles in wealth inequality. Our findings link recent shifts in financial market structure to macroeconomic outcomes.
Publications
Multilayer Networks For Text Analysis With Multiple Data Types
with Yuanming Tao, Lamiae Azizi, Martin Gerlach, Tiago P. Peixoto, and Eduardo G. Altmann
Winner of Best Thesis at University of Sydney Mathematics Department
Abstract:
We are interested in the widespread problem of clustering documents and finding topics in large collections of written documents in the presence of metadata and hyperlinks. To tackle the challenge of accounting for these different types of datasets, we propose a novel framework based on Multilayer Networks and Stochastic Block Models. The main innovation of our approach over other techniques is that it applies the same non-parametric probabilistic framework to the different sources of datasets simultaneously. The key difference to other multilayer complex networks is the strong unbalance between the layers, with the average degree of different node types scaling differently with system size. We show that the latter observation is due to generic properties of text, such as Heaps’ law, and strongly affects the inference of communities. We present and discuss the performance of our method in different datasets (hundreds of Wikipedia documents, thousands of scientific papers, and thousands of E-mails) showing that taking into account multiple types of information provides a more nuanced view on topic- and document-clusters and increases the ability to predict missing links.
Working Papers
Monetary Policy in the Presence of Tail Risks (JMP)
Presentations: LSE Macro PhD Workshop
Abstract
I study how monetary policy should respond to time-varying tail risks. I set out a New‑Keynesian macro‑finance model in which all higher‑order moments of uncertainty feeds directly into asset prices, the natural real rate and the optimal policy rule. Real economic activity is driven by wealth effects. When higher‑order moments dominate asset prices, a central bank that targets only the first two moments leaves sizable, welfare‑relevant risk premia unattended. I derive a closed‑form risk‑balance condition: a fatter left tail depresses consumption via wealth effects and therefore requires additional monetary accommodation. The VIX emerges as a sufficient statistic for these higher‑order risks. Calibrating the model to U.S. data with a jump‑diffusion process, I find that a 1 percentage‑point rise in disaster probability lowers the natural real rate by 30bp and raises the welfare‑relevant equity premium by almost 20bp, generating business‑cycle costs of roughly 320bp. Restoring potential output demands that policy systematically lean against all higher‑order risks, flattening the entire cumulant term structure and stabilising aggregate demand.
Financial Stability Implications of Central Bank Digital Currencies: A Solution in Search of a Problem?
Winner of Best Doctoral Paper at Saïd Business School, 2023
Abstract
How does the introduction of a retail central bank digital currency (CBDC) affect monetary policy transmission and financial stability? To answer this, I construct a stochastic general equilibrium model with aggregate uncertainty, incomplete markets, liquidity constraints, endogenous default, and hetero- geneous banks with market power. A monopsonistic banking sector charges a markdown on commercial deposit rates, leading to a loss in household welfare and dampened monetary policy transmission. Introducing a retail CBDC increases competition in the banking sector and injects liquidity into the economy. This creates a tradeoff with financial instability, as the use of the CBDC disintermediates the financial sector. Deposit outflows increase funding costs and decrease credit supply, leading output to contract. With aggregate uncertainty, the introduction of a risk-free CBDC leads to an 8% reduction in welfare.
Convenience Yields as Fiscal Space
with Tobias Kawalec
Abstract
We study the role that safe-asset premia (“convenience yields”), a pervasive feature of advanced-economy public debt, has on inflation dynamics. Because inflation determinacy requires coordinated monetary–fiscal policy, shifts in the effective debt service induced by these premia can alter determinacy regions. To study this mechanism, we develop a two-country, continuous-time New Keynesian model. We introduce a stochastic safe-asset-demand wedge in households’ Euler equations that both disciplines exchange-rate dynamics and shifts equilibrium determinacy. The wedge lowers effective real debt service and relaxes government budget dynamics, enlarging the determinacy region for standard monetary–fiscal policy mixes. Internationally, the same wedge attenuates pass-through from marginal-utility shocks to exchange rates, helping reconcile exchange-rate volatility, failure of UIP, and exchange-rate disconnect puzzles while altering how Taylor rules and fiscal feedbacks pin down the price level. We map the determinacy frontier with and without convenience yields and show that empirically plausible premia materially expand the set of policies delivering a unique price-level path in the two-country setting.
Who Holds the Risk? Demographics and the Market Price of Risk
Abstract
This paper develops a continuous-time endowment economy in which demographics shape asset prices through a composition channel. In a Blanchard–Yaari environment with gradual retirement, the share of consumption financed by dividends rather than labor income becomes the sufficient statistic that links population aging to the price of risk. When retirements are longer or earnings decline more steeply with age, the economy relies more on dividend income to finance consumption. Because dividend income is more exposed to aggregate risk than labor income in the data, this compositional shift raises consumption volatility, increases the volatility of the pricing kernel, and thereby elevates the market price of risk and risk premia. Longer lifespans also reduce the risk‑free rate directly through lower mortality discounting and indirectly through higher consumption volatility; longer retirements tend to depress the risk‑free rate through the volatility channel while raising risk premia. The mechanism delivers an alternative to rare‑disaster narratives for understanding secular movements in risk premia.
State-Price Targeting: A Macro-Finance Approach for Price-Level Determination
with Theofanis Papamichalis, and Dimitrios P. Tsomocos
Abstract
We show that price-level determinacy in an uncertain world depends on whether state-contingent prices are pinned down. Unless the nominal equivalent martingale measure, the risk-neutral distribution over nominal states, is pinned down, the distribution of inflation remains indeterminate. Standard interest-rate rules fix discount factors but not the risk-neutral distribution across states; as a result, they discipline only the average of inflation and leave both nominal asset prices and the distribution of inflation undetermined. We propose State-Price Targeting: the central bank pegs a small set of option prices that span states, thereby choosing the risk-neutral distribution directly which restores price-level determinacy. The mechanism exploits liquidity: state prices scale with the money-market discount factor, so low-rate, high-liquidity regimes are low-state-price regimes, while the chosen measure allocates that liquidity across states. By jointly choosing the short rate and the risk-neutral distribution, the central bank can pin down inflation branch by branch. We propose an implementation of this rule where the central bank can trade a full span of options with standard fiscal backing to deliver price-level determinacy.