We present a rational expectations model of credit-driven crises, providing a new perspective to explain why credit booms can lead to severe financial crises and aftermath slow economic recoveries. In our model economy, banks can operate in two types of business. They are sequentially aware of the deterioration of fundamentals of the speculative business and decide whether to continue credit extension in that business or liquidate capital and move into the traditional business. However, because individual banks face uncertainty about how many of their peers have been aware, they rationally choose to extend credit in the speculative business for a longer time than is socially optimal, leading to an over-delayed crisis and consequently more banks being caught by the crisis. This in turn renders the financial crisis more severe and the subsequent economic recovery slower. Extending to a standard textbook macroeconomic growth setting, our model also generates rich dynamics of economic booms, slowdowns, crashes, and recoveries.
- Ph.D., MSc, London School of Economics (LSE)
- MSc, Fudan University
- BSc, University of Shanghai for Science and Technology
Professor Xuewen Liu is currently a full professor at HKU. Prior to joining HKU, he was an associate professor and an assistant professor at HKUST and was an assistant professor at Imperial College Business School. He obtained his Ph.D. degree at London School of Economics (LSE).
Professor Liu is an economic theorist. His research areas include financial economics (corporate finance, financial markets, financial institutions, and financial crises), macroeconomics, growth and development, and Chinese economy.
Professor Liu has published in leading finance and economics journals, such as Journal of Finance, Journal of Financial Economics, Review of Financial Studies, Journal of Economic Theory, Journal of Monetary Economics.
- Financial Economics
- Macroeconomics
- Growth and Development
- Chinese Economy
- Asset-market Sentiments and Business-cycle Fluctuations (with Pengfei Wang and Sichuang Xu), 2024, International Economic Review, forthcoming.
- Delayed Crises and Slow Recoveries (with Pengfei Wang and Zhongchao Yang), 2024, Journal of Financial Economics, 152, 103757.
- A Model of Systemic Bank Runs, 2023, Journal of Finance, 78(2), 731-793.
- Exchange-Traded Funds and Real Investment (with Constantinos Antoniou, Frank Weikai Li, Avanidhar Subrahmanyam, and Chengzhu Sun), 2023, Review of Financial Studies, 36(3), 1043–1093.
- Financial Markets, the Real Economy, and Self-Fulfilling Uncertainties (with Jess Benhabib and Pengfei Wang), 2019, Journal of Finance, 74(3), 1503-1557.
- Credit Expansion and Credit Misallocation (with Alexander Bleck), 2018, Journal of Monetary Economics, 94, 27-40.
- The Creditor Channel of Liquidity Crises (with Antonio S. Mello), 2017, Journal of Money, Credit and Banking, 49(6), 1113-1160.
- Endogenous Information Acquisition and Countercyclical Uncertainty (with Jess Benhabib and Pengfei Wang), 2016, Journal of Economic Theory, 165, 601-642.
- Interbank Market Freezes and Creditor Runs, 2016, Review of Financial Studies, 29(7), 1860-1910.
(Yihong Xia Best Paper Award, China International Conference in Finance, 2014) - Sentiments, Financial Markets, and Macroeconomic Fluctuations (with Jess Benhabib and Pengfei Wang), 2016, Journal of Financial Economics, 120(2), 420-443.
- Short-Selling Attacks and Creditor Runs, 2015, Management Science, 61(4), 814-830.
- The Fragile Capital Structure of Hedge Funds and the Limits to Arbitrage (with Antonio S. Mello), 2011, Journal of Financial Economics, 102(3), 491-506.
- Market Transparency and the Accounting Regime (with Alexander Bleck), 2007, Journal of Accounting Research, 45(2), 229-256.
We develop a tractable model of systemic bank runs. The market-based banking system features a two-layer structure: banks with heterogeneous fundamentals face potential runs by their creditors while they trade short-term funding in the asset (interbank) market in response to creditor withdrawals. The possibility of a run on a particular bank depends on its assets' interim liquidation value, and this value depends endogenously in turn on the status of other banks in the asset market. The within-bank coordination problem among creditors and the cross-bank price externality feed into each other. A small shock can be amplified into a systemic crisis.
We investigate the link between exchange-traded funds and real investment. Cross-sectionally, higher ETF ownership is associated with an increased sensitivity of real investment to Tobin’s q and a heightened ability of stock returns to forecast future earnings. Inclusion of stocks in industry ETFs enhances investment-q sensitivity and implies greater incorporation of earnings information into prices prior to public releases. Greater nonmarket ETF ownership leads to increased (reduced) reliance of real investment on own (peers’) stock prices. Overall, the evidence is consistent with ETFs positively affecting real investment efficiency via greater flows of information.