Financial Stability and the Real Economy – F-STAR

The project F*STAR (Financial STAbility and the Real economy) is an extensive research program in the fields of financial economics and macro-finance. It focuses on the relationship between the funding policy of firms (both financials and non-financials) and the real economy. While funding of banks and corporations is an extremely broad topics, we will focus in this project on short-term funding. This type of funding corresponds to a large and growing fraction of the balance-sheet of banks and corporations and it is inherently seen as the most fragile source of funding. Furthermore, there is a direct and fundamental relationship between corporation funding and the real economy: Indeed a drop in funding leads to reduced investment, lower performance and negatively impacts employment and economic growth. While empirical investigations still remain scarce in academia because of lack of data on these over-the-counter debt markets, our empirical analyses will exploit unique data provided to us by the Banque de France.
The F*STAR research team comprises seven researchers from HEC Paris, GREGHEC (CNRS UMR 2959), the Massachusetts Institute of Technology (USA), and Imperial College (UK). It combines experts from the fields of economics, banking, corporate finance, asset management, as well as regulation and spans both theory and empirics. The F*STAR project is divided into four subprojects or work packages, which capture various facets of the corporate funding market.

Work package 1 - Stability of the Bank’s Wholesale Funding Market: In addition to deposits and central bank funding, commercial banks rely increasingly on financial markets (i.e., wholesale funding): interbank loans, repurchase agreements, and short-term debt securities sold to institutional investors. A prevailing view among economists and regulators is that wholesale funding is vulnerable to sudden stops, during which banks lose funding regardless of their credit quality. We will test empirically the resiliency of several segments of the wholesale funding market, as well as the effects of funding dry-ups on bank performance and on the macroeconomy.

Work package 2 - Private Production of Safe Assets by Banks and Non-Financial Firms: Can claims on the private sector serve the role of safe assets? We will try to answer this question using high-frequency panel data on prices and quantities of European certificates of deposit (CD) issued by commercial banks, and commercial paper (CP) issued by non-financial institutions. We will measure the safety premium on all assets and study the joint-dynamics of privately-issued and government-issued safe assets.

Work package 3 - Short-Term Debt Issuance of Non-Financial Firms: What is the rational for non-financial firms to massively use cash to repay their short-term debt at the end of the fiscal year? This phenomenon, which we will document for the first time in the literature, constitutes a puzzle for corporate finance theory as only net leverage, not gross leverage, is relevant to measure shareholders’ net wealth. We will investigate whether this pattern can be explained by a novel informational friction: asymmetric information between corporate insiders and outside financiers about the level of free cash holdings.

Work package 4 - Theory of Collateral for Funding Markets: Why do some of the most developed debt markets rely so heavily on collateral? In this work package, we will theoretically explore the role of collateral in insulating creditors from the claims of other creditors, rather than from the actions of borrowers. This may imply that collateral should indeed be prevalent in environments where cash flow pledgeability is high, not low. Indeed, in such environments, taking on new debt is easier, leading creditors to require collateral as protection against debt dilution. We aim to develop a model based on that premise and explore its implications.