Nicolae Bogdan Gârleanu

Associate Professor of Finance, Paul H. Stephens Chair in Applied Investment Analysis, Haas School of Business, University of California, Berkeley
Research Associate, National Bureau of Economic Research (NBER)
Research Fellow, Centre for Economic Policy Research (CEPR)

Contact Information
F628 Faculty Building
CA 94720
Office phone: (1) 510 642 3421
Fax : (1) 510 643 1420

Curriculum Vitae and Research Agenda

Here is a PDF version of my resume. For a short description of my research agenda (October 2008), click here.


"Financial Entanglement: A Theory of Incomplete Integration, Leverage, Crashes, and Contagion" (with Stavros Panageas and Jianfeng Yu). American Economic Review, conditionally accepted.
Tractable model of incomplete integration, which generates contagion. Leverage may arise endogenously, and can cause crashes. Abstract.

"Young, Old, Conservative, and Bold: The Implications of Heterogeneity and Finite Lives for Asset Pricing" (with Stavros Panageas). Journal of Political Economy, forthcoming.
Solution of the two-person problem with recursive utilities and overlapping generations. Highlight implications for asset pricing. Abstract.

"Dynamic Trading with Predictable Returns and Transaction Costs" (with Lasse Heje Pedersen). Journal of Finance, vol. 68 (2013), issue 6, pp. 2309-2340.
The optimal dynamic portfolio policy when security returns are predictable -- possibly by several predictors with different precisions and persistence -- and trading is costly. Abstract.

"Displacement Risk and Asset Returns" (with Leonid Kogan and Stavros Panageas). Journal of Financial Economics, vol. 105 (2012), issue 3, pp. 491-510.
Best-Paper Award at the Utah Winter Finance Conference, 2011.
If innovation benefits the young at the expense of the old, then growth firms are a good hedge, while risk premia are larger and interest rates smaller than in the classical Lucas-tree model. Theory, supporting empirical evidence, and numerical calibration. Abstract.

"Technological Growth and Asset Prices" (with Stavros Panageas and Jianfeng Yu). Journal of Finance, vol. 67 (2012), issue 4, pp. 1265-1292.
Smith Breeden Prize (first prize), 2012.
Large-scale technological innovations followed with some delay by increased investment and consumption can help explain a number of properties of the joint behavior of consumption and asset prices. Abstract.

"Margin-Based Asset Pricing and the Law of One Price" (with Lasse Heje Pedersen). Review of Financial Studes, vol. 24 (2011), no. 6, pp. 1980-2022.
Michael Brennan Award for Best Paper in the RFS, 2012.
Higher-margin securities have higher returns and volatilities, especially during credit crises. Theory and empirics. Abstract.

"Two Monetary Tools: Interest Rates and Haircuts" (with Adam Ashcraft and Lasse Heje Pedersen).
NBER Macroeconomics Annual (2010).
Reducing security margins, e.g., as the TALF did, can have significant pricing implications. Theory and empirics. Abstract.

"Pricing and Portfolio Choice in Illiquid Markets"
Journal of Economic Theory, vol. 144 (2009), no. 2, pp. 532-564.
The effect of the inability to trade immediately on optimal portfolio choice and equilibrium price. Abstract.

"Demand-Based Option Pricing" (with Lasse Heje Pedersen and Allen Poteshman).
The Geewax, Terker, & Company First Prize in Investment Research, Rodney White Center, 2006.
Review of Financial Studies, vol. 22 (2009), no. 10, pp. 4259-4299.
The effect of end-user demand on option prices when dealers cannot perfectly hedge. Theory and supportive empirics. Abstract.

"Liquidity and Risk Management" (with Lasse Heje Pedersen).
American Economic Review Papers and Proceedings, vol. 97 (2007), pp. 193-197.
Stricter risk-management requirements can reduce liquidity (and prices), especially if they are tied to the liquidity level. Abstract.

"Valuation in Over-the-Counter Markets" (with Darrell Duffie and Lasse Heje Pedersen).
Review of Financial Studies, vol. 20 (2007), no. 5, pp. 1865-1900.
The effect of search and bargaining on asset prices. Abstract.

"Design and Renegotiation of Debt Covenants" (with Jeffrey Zwiebel)
Review of Financial Studies, vol. 22 (2009), no.2, pp. 749-781.
The creditor, having inferior information, receives stronger control rights -- i.e., covenants are stricter -- than optimal. Abstract.

"Over-the-Counter Markets" (with Darrell Duffie and Lasse Heje Pedersen).
Econometrica, vol 73 (2005), pp. 1815-1847.
Marketmakers' spread is narrower for sophisticated investors with better search options (NB: reverse of information-based models). Abstract.

"Adverse Selection and the Required Return" (with Lasse Heje Pedersen).
Review of Financial Studies, vol. 17 (2004), no. 3, pp. 643-665.
Future adverse-selection based bid-ask spreads need not constitute a trading cost. Abstract.

"Securities Lending, Shorting, and Pricing" (with Darrell Duffie and Lasse Heje Pedersen).
NYSE Award for best paper on equity trading, Western Finance Association, 2002.
Journal of Financial Economics, vol. 66 (2002), pp. 307-339.
Short sellers search for stock owners and pay a lending fee. The lending fee, acting as a dividend, increases the stock's price. Abstract.

"Risk and Valuation of Collateral Debt Obligations" (with Darrell Duffie).
Graham and Dodd Award of Excellence, Association for Investment Management and Research, 2001.
Financial Analysts Journal, vol.57 (2001), no. 1 (January-February), pp. 41-59.
Model CDOs to calcluate value of each tranche. Compare risk estimates with those of rating agencies. Abstract.

Working Papers

"Auctions with Endogenous Selling" (with Lasse Heje Pedersen).
The effect of market structure on volume, prices, and welfare, when owners and potential buyers have information. Abstract.

"Dynamic Portfolio Choice with Frictions" (with Lasse Heje Pedersen). Appendix.
Tractable continuous-time model of portfolio choice with transaction costs and many securities and predictors. Conditions for transitory transaction costs in continuous time. Broad applicability to economics and even beyond. Abstract.





Paper Abstracts

"Liquidity and Risk Management" This paper provides a model of the interaction between risk-management practices and market liquidity. On one hand, tighter risk management reduces the maximum position an institution can take, thus the amount of liquidity it can offer to the market. On the other hand, risk managers can take into account that lower liquidity amplifies the effective risk of a position by lengthening the time it takes to sell it. The main result of the paper is that a feedback effect can arise: tighter risk management reduces liquidity, which in turn leads to tighter risk management, etc. This can help explain sudden drops in liquidity and, since liquidity is priced, in prices in connection with increased volatility or decreased risk-bearing capacity.

"Design and Renegotiation of Debt Covenants"
We analyze the design and renegotiation of covenants in debt contracts as a particular example of the contractual assignment of property rights under asymmetric information. In particular, we consider a setting where future firm investments are efficient in some states, but also involve a transfer from the lender(s) to shareholders. While there is symmetric information regarding investment efficiency, managers are better informed about any potential transfer than the lender. The lender can learn this information, but at a cost. In this setting, we show that the simple adverse selection problem leads to the allocation of greater ex-ante decision rights to the uninformed party than would follow under symmetric information. Consequently, ex-post renegotiation is in turn biased towards the uninformed party giving up these excessive rights. In many settings, this result yields the opposite implication from standard Property Rights results regarding contracting under incomplete contracts and ex-ante investments, whereby rights should be allocated to minimize inefficiencies due to distortions in ex-ante investments. Indeed, for debt contracts as well as other settings, the uninformed party, who receives strong decision rights in our setting, is likely to have few significant ex-ante investments to undertake relative to the informed party.

"Over-the-Counter Markets"
We study how intermediation and asset prices in over-the-counter markets are affected by illiquidity associated with search and bargaining. We compute explicitly the prices at which investors trade with each other, as well as marketmakers' bid and ask prices in a dynamic model with strategic agents. Bid-ask spreads are lower if investors can more easily find other investors, or have easier access to multiple marketmakers. With a monopolistic marketmaker, bid-ask spreads are higher if investors have easier access to the marketmaker. We characterize endogenous search and welfare, and discuss empirical implications.

"Adverse Selection and the Required Return"
An important feature of financial markets is that securities are traded repeatedly by asymmetrically informed investors. We study how current and future adverse selection affect the required return. We find that the bid-ask spread generated by adverse selection is not a cost, on average, for agents who trade, and hence the bid-ask spread does not directly influence the required return. Adverse selection contributes to trading-decision distortions, however, implying allocation costs, which affect the required return. We explicitly derive the effect of adverse selection on required returns, and show how our result differs from models that consider the bid-ask spread to be an exogenous cost.

"Securities Lending, Shorting, and Pricing"
We present a model of asset valuation in which short-selling is achieved by searching for security lenders and by bargaining over the terms of the lending fee. If lendable securities are difficult to locate, then the price of the security is initially elevated, and expected to decline over time. This price decline is to be anticipated, for example, after an initial public offering (IPO), among other cases, and is increasing in the degree of heterogeneity of beliefs of investors about the likely future value of the security. The prospect of lending fees may push the initial price of a security above even the most optimistic buyer's valuation of the security's future dividends. A higher price can thus be obtained with some shorting than if shorting is disallowed.

"Risk and Valuation of Collateral Debt Obligations"
This paper addresses the risk analysis and market valuation of collateralized debt obligations (CDOs). We illustrate the effects of correlation and prioritization for the market valuation, diversity score, and risk of CDOs, in a simple jump-diffusion setting for correlated default intensities.

"Valuation in Over-the-Counter Markets"
We provide the impact on asset prices of search-and-bargaining frictions in over-the-counter markets. Under certain conditions, prices are lower and illiquidity discounts higher when counterparties are harder to find, when sellers have less bargaining power, when the fraction of qualified owners is smaller, or when risk aversion, volatility, or hedging demand are larger. If agents face risk limits, then higher volatility leads to greater difficulty locating unconstrained buyers, resulting in lower prices. We discuss a variety of financial applications and testable implications.

"Auctions with Endogenous Selling"
The seminal paper by Milgrom and Weber (1982) ranks the expected revenues of several auction mechanisms, taking the decision to sell as exogenous. We endogenize the sale decision. The owner decides whether or not to sell, trading off the conditional expected revenue against his own use value, and buyers take into account the information contained in the owner's sale decision. We show that revenue ranking implies volume and welfare ranking under certain general conditions. We use this to show that, with affiliated signals, English auctions have larger expected price, volume, and welfare than second-price auctions, which in turn have larger expected price, volume, and welfare than first-price auctions.

"Demand-Based Option Pricing"
We model demand-pressure effects on option prices. The model shows that demand pressure in one option contract increases its price by an amount propor- tional to the variance of the unhedgeable part of the option. Similarly, the de- mand pressure increases the price of any other option by an amount proportional to the covariance of the unhedgeable parts of the two options. Empirically, we identify aggregate positions of dealers and end users using a unique dataset, and show that demand-pressure effects make a contribution to well-known option- pricing puzzles. Indeed, time-series tests show that demand helps explain the overall expensiveness and skew patterns of index options, and cross-sectional tests show that demand impacts the expensiveness of single-stock options as well.

"Pricing and Portfolio Choice in Illiquid Markets"
This paper studies portfolio choice and pricing in markets in which immediate trading may be impossible. It departs from the literature by removing restrictions on asset holdings, and finds that optimal positions depend significantly and naturally on liquidity: When expected future liquidity is high, agents take more extreme positions, given that they do not have to hold those positions for long when they become undesirable. Consequently, larger trades should be observed in markets with more frequent trading. Liquidity need not affect the price significantly, however, because liquidity has offsetting impacts on different agentsf demands. This result highlights the importance of unrestricted portfolio choice. The paper draws parallels with the transaction-cost literature and clarifies the relationship between the price level and the realized trading frequency in this literature.

"Young, Old, Conservative, and Bold: The Implications of Heterogeneity and Finite Lives for Asset Pricing"
We study the implications of preference heterogeneity for asset pricing. We use {recursive} preferences in order to separate heterogeneity in risk aversion from heterogeneity in the intertemporal elasticity of substitution, and an overlapping-generations framework to obtain a non-degenerate stationary equilibrium. We solve the model explicitly up to the solutions of ordinary differential equations, and highlight the effects of overlapping generations and each dimension of preference heterogeneity on the market price of risk, interest rates, and the volatility of stock returns. We find that separating IES and risk aversion heterogeneity can have a substantive impact on the model's (qualitative and quantitative) ability to address some key asset pricing issues.

"The Demographics of Innovation and Asset Returns"
We study an overlapping-generations economy in which new agents innovate and introduce new products and firms. Innovation is stochastic. The new firms increase overall productivity, but also steal business from pre-existing firms. Furthermore, the human capital of existing agents decreases, relatively, with innovation. Consequently, increased innovation activity hurts existing agents at the same time that firms that benefit from innovation do well. This phenomenon confers a hedging value to such firms, i.e., the model produces a value effect. At the aggregate level the human-capital risk makes agents reluctant to hold stock of existing firms, since their profits are collectively at risk from new entrants. This leads to a higher equity premium and a lower risk-free rate. We calibrate the model so that it matches estimated cohort effects for individuals and firms, and evaluate its quantitative implications.

"Dynamic Trading with Predictable Returns and Transaction Costs"
This paper derives in closed form the optimal dynamic portfolio policy when trading is costly and security returns are predictable by signals with different mean-reversion speeds. The optimal updated portfolio is a linear combination of the existing portfolio, the optimal portfolio absent trading costs, and the optimal portfolio based on future expected returns and transaction costs. Predictors with slower mean reversion (alpha decay) get more weight since they lead to a favorable positioning both now and in the future. We implement the optimal policy for commodity futures and show that the resulting portfolio has superior returns net of trading costs relative to more naive benchmarks. Finally, we derive natural equilibrium implications, including that demand shocks with faster mean reversion command a higher return premium.

"Margin-Based Asset Pricing and the Law of One Price"
In a model with multiple agents with different risk aversions facing margin constraints, we show how securities' required returns are characterized both by their beta and their margins. Negative shocks to fundamentals make margin constraints bind, lowering risk free rates and raising required Sharpe ratios of risky securities, especially for high-margin securities. Such a funding liquidity crisis gives rise to a ``basis,'' that is, a price gap between securities with identical cash-flows but different margins. In the time series, the basis depends on the shadow cost of capital which can be captured through the interest-rate spread between collateralized and uncollateralized loans, and, in the cross section, it depends on relative margins. We apply the model empirically to the CDS-bond basis and other deviations from the Law of One Price, and to price the Fed's lending facilities.

"Technological Growth and Asset Prices"
In this paper we study the implications of general-purpose technological growth for asset prices. The model features two types of shocks: ``small", frequent, and disembodied shocks to productivity and ``large" technological innovations, which are embodied into new vintages of the capital stock. While the former affect the economy on impact, the latter affect the economy with lags, since firms need to first adopt the new technologies through investment. The process of adoption leads to cycles in asset valuations and risk premia as firms convert the growth options associated with the new technologies into assets in place. This process can help provide a unified, investment-based view of some well documented phenomena such as the asset-valuation patterns around major technological innovations, the countercyclical behavior of returns, the lead-lag relationship between the stock market and output, and the increasing patterns of consumption-return correlations over longer horizons.

"Two Monetary Tools: Interest Rates and Haircuts"
We study a production economy with multiple sectors financed by issuing securities to agents who face capital constraints. Binding capital constraints propagate business cycles, and a reduction of the interest rate can increase the required return of high haircut assets since it can increase the shadow cost of capital for constrained agents. The required return can be lowered by easing funding constraints through lowering haircuts. To assess empirically the power of the haircut tool, we study the natural experiment of the introduction of the legacy Term Asset-Backed Securities Loan Facility (TALF). By considering unpredictable rejections of bonds from TALF, we estimate that haircuts had a significant effect on prices. Further, unique survey evidence suggests the effect could be more than 3% and provides broader evidence on the demand sensitivity to haircuts.

"Financial Entanglement: A Theory of Incomplete Integration, Leverage, Crashes, and Contagion"
We propose a unified model of limited market integration, asset-price determination, leveraging, and contagion. Investors and firms are located on a circle, and access to markets involves participation costs that increase with distance. Despite the ex-ante symmetry of investors, their strategies may (endogenously) exhibit diversity, with some investors in each location following high-leverage, high-participation, and high-cost strategies and some unleveraged, low-participation, and low-cost strategies. The capital allocated to high-leverage strategies may be vulnerable even to small changes in market-access costs, which can lead to discontinuous price drops, de-leveraging, and portfolio-flow reversals. Moreover, the market is subject to contagion, in that an adverse shock to investors at a subset of locations affects prices everywhere.

"Dynamic Portfolio Choice with Frictions"
We show that the optimal portfolio can be derived explicitly in a large class of mod- els with transitory and persistent transaction costs, multiple signals predicting returns, multiple assets, general correlation structure, time-varying volatility, and general dynamics. Our tractable continuous-time model is shown to be the limit of discrete-time models with endogenous transaction costs due to optimal dealer behavior. Depending on the dealers' inventory dynamics, we show that transitory transaction costs survive, respectively vanish, in the limit, corresponding to an optimal portfolio with bounded, respectively quadratic, variation. Finally, we provide equilibrium implications and illustrate the model's broader applicability to economics.