Recent Advances in Empirical Analysis of Financial Markets: Industrial Organization Meets Finance

Abstract

In this article I provide a selective review of recent empirical work in the intersection of finance and industrial organization. I describe an estimation method, which can be applied quite widely in financial and other markets where a researcher needs to recover agents’ beliefs. Using four applications I illustrate how combining this method with data from auctions and with a theoretical model can be used to answer various economic questions of interest. I start with the primary market for sovereign debt, focusing on treasury bill auctions of the USA and Canada. I show how auction data together with standard tools from Industrial Organization can be used to shed light on issues involving market structure, market power and front-running. I continue by looking at the Main Refinancing Operations of the European Central Bank, the main channel of monetary policy implementation in the Eurozone, and illustrate how auction data can be used to learn about typically opaque over-the-counter lending markets. I also discuss how to use these data indirectly to learn about dynamics of banks’ financial health and of their balance sheets. I then turn to the discussion of recent progress on estimation of systemic risk. I finish with thoughts on how to estimate a whole demand system for financial assets. INTRODUCTION The last three decades marked a remarkable success in the development of tools in structural economic modeling, predominantly within the field of industrial organization. These techniques and tools can be applied more widely and the recent developments in finance and other areas suggest that indeed there are many promising directions in which the literature can go. In this article I will talk about applying various tools from industrial organization to financial markets. The markets I will focus on here are (i) market for sovereign debt, and (ii) market for liquidity (short-term loans). I will argue that these and similar markets provide us with an abundance of data and studying them can allow us to gain insights into many other areas of the economy. I will point out some open questions as I move through the applications.