Nicolae Bogdan Gârleanu

Professor of Finance, H. Frederick Hagemann Jr. Professor, Olin School of Business, WashU
Research Associate, National Bureau of Economic Research (NBER)

Contact Information
1 Brookings Drive
Campus Box 1133
St. Louis, MO 63130
Office phone: (1) 314 935 4678

Curriculum Vitae

Here is a PDF version of my resume.


"Heterogeneity and Asset Prices: A Different Approach" (with Stavros Panageas).
Journal of Political Economy, vol. 131 (2023), pp. 839-876.
With overlapping generations, marginal agent may face (long-run) risk even absent aggregate risk, accounting for the salient asset-pricing facts. Empirical measurement of marginal-aggregate wedge and its implications. Abstract.

"Active and Passive Investing" (with Lasse Heje Pedersen).
Review of Asset Pricing Studies, vol. 12 (2022), pp. 389-446.
Properties of active and passive investment strategies. Determinants of the sizes of active and passive investment sectors. Resulting properties of price informativeness, including Samuelson's Dictum. Abstract.

"What to Expect when Everyone is Expecting: Self-Fulfilling Expectations and Asset-Pricing Puzzles" (with Stavros Panageas).
Journal of Financial Economics, vol. 140 (2021), pp. 54-73.
Expectations, by redistributing wealth across investor cohorts, can constitute source of volatility and risk premiums. No bubbles, or fundamental risk, necessary. Abstract.

"Impediments to Financial Trade: Theory and Applications" (with Stavros Panageas and Jianfeng Yu).
Review of Financial Studies, vol. 33 (2020), pp. 2697-2727.
Theoretical model showing how information asymmetries can translate into bilateral taxes on investing in various different ''locations.'' This can justify observed portfolio biases, including non-participation in certain asset classes. Abstract.

"Efficiently Inefficient Markets for Assets and Asset Management" (with Lasse Heje Pedersen).
Journal of Finance, vol. 78 (2018), issue 4, pp. 1663-1712.
Brattle Group Prize (distinguished paper), 2018.
AIM Investment Center Best Paper Award, 2016.
Model investors having to pay cost to match with good asset managers. The equilibrium links the efficiency of the asset market with that of the market for managers.

"Dynamic Portfolio Choice with Frictions" (with Lasse Heje Pedersen). Appendix.
Journal of Economic Theory, vol. 165 (2016), pp. 487-516.
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.

"Financial Entanglement: A Theory of Incomplete Integration, Leverage, Crashes, and Contagion" (with Stavros Panageas and Jianfeng Yu).
American Economic Review, vol. 105 (2015), issue 7, pp. 1979-2010.
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, vol. 123 (2015), issue 3, pp. 670-685.
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. Corrigendum. 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.

"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.

"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.

"Over-the-Counter Markets" (with Darrell Duffie and Lasse Heje Pedersen).
Econometrica, vol 73 (2005), pp. 1815-1847.
Ross Prize in Financial Economics, 2021.
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.

"A Long and a Short Leg Make For a Wobbly Equilibrium" (with Stavros Panageas and Geoff Zheng).
Shorting fees can give rise to multiple equilibria and create instability. Evidence from the WSB subreddit, Nov 2020 – Jan 2021. Abstract.

Work in Progress

"Finance in a Time of Disruptive Growth" (with Stavros Panageas). Coming soon.
In response to a secular increasing trend in economic disruption, the financial industry proposes increasingly farther reaching instruments allowing risk sharing, thus explaining a simultaneous increase in the importance of ''alternative investment classes.'' 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' 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.

"Displacement Risk 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. Corrigendum.

"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.

"Impediments to Financial Trade: Theory and Applications"
We propose a tractable model of an informationally inefficient market featuring nonrevealing prices, general preferences and payoff distributions, but not noise traders. We show the equivalence between our model and a substantially simpler one in which investors face distortionary investment taxes depending on both their identity and the asset class. This equivalence allows us to account for such phenomena as underdiversification. We further employ the model to assess approaches to performance evaluation and find that it provides a theoretical basis for some intuitive practices, such as style analysis, that have been adopted by finance professionals.

"Efficiently Inefficient Markets for Assets and Asset Management"
We consider a model where investors can invest directly or search for an asset manager, information about assets is costly, and managers charge an endogenous fee. The efficiency of asset prices is linked to the efficiency of the asset management market: if investors can find managers more easily, more money is allocated to active management, fees are lower, and asset prices are more efficient. Informed managers outperform after fees, uninformed managers underperform after fees, and the net performance of the average manager depends on the number of ''noise allocators.'' Small investors should be passive, but large and sophisticated investors benefit from searching for informed active managers since their search cost is low relative to capital. Hence, managers with larger and more sophisticated investors are expected to outperform.

"Drifting Apart: The Pricing of Assets when the Benefits of Growth are not Shared Equally"
A significant fraction of the growth of aggregate market capitalization is due to new firm entry. With incomplete markets, the gains from new firm creation are not shared equally; these gains accrue to a small part of the population, while constituting a risk for the marginal investor who holds a portfolio of existing firms, which face potential displacement by the arriving firms. We propose a simple model to capture these notions. We use the model to develop a simple methodology to measure this displacement risk, which relies on the discrepancy in the growth rates of aggregate dividends and of the gains from the self-financing trading strategy associated with maintaining a market-weighted portfolio. We find that our measure of displacement risk is closely linked to certain cross-sectional asset-pricing phenomena and can explain a sizable fraction of the equity premium. We argue more generally that dispersion in capital income, a source of risk overlooked in representative agent models, has first-order implications for asset pricing.

"What to Expect when Everyone is Expecting: Self-Fulfilling Expectations and Asset-Pricing Puzzles"
We study an economy without bubbles in which expectations about future discount rates can become self-fulfilling because asset valuations redistribute wealth across different investor cohorts. For such redistribution to take place, the wealth of arriving and existing cohorts must react differently to discount rates, and in addition only the existing agents be marginal in financial markets. The self-fulfilling nature of discount rate expectations means that the economy can address several well documented empirical asset pricing facts (excessive volatility, return predictability, low interest rate level and volatility), while all real quantities (aggregate consumption and dividend growth) are smooth.

"Heterogeneity and Asset Prices: A Different Approach"
In an overlapping-generations economy the consumption growth of a given cohort member (the ``marginal agent'') differs from the aggregate consumption growth. A cohort member is faced with long-run consumption uncertainty even in the absence of aggregate (and within-cohort) consumption risk. This uncertainty allows the model to account for several stylized asset-pricing facts (high market price of risk and volatility, return predictability, low and non-volatile interest rate) despite deterministic macroeconomic aggregates and inequality measures that are contemporaneously uncorrelated with asset returns. We devise and implement a methodology to measure the marginal agent’s consumption growth and evaluate the model's quantitative implications.

"Finance in a Time of Disruptive Growth"
We build a model in which the arrival of new technologies displaces demand for old technologies. This disruption causes redistribution due to lack of risk sharing both within and across investor cohorts. We model the financial industry as a costly device to improve risk sharing, and determine its size in equilibrium. We further study wealth dynamics, equilibrium prices, and flows into various asset classes. We show that an increase in disruptive activity renders existing firms’ publicly traded equities riskier and renders “alternative asset classes” as diverse as fixed income, real estate, and private equity more attractive. The result is a decline in the real interest rate, an expansion of the financial industry, and increased flows towards alternative asset classes. Interestingly, alternative asset classes offer higher expected rates of return than conventional equities despite the diversification benefits afforded by the former.

"Active and Passive Investing"
We model how investors allocate between asset managers, managers choose their portfolios of multiple securities, fees are set, and security prices are determined. The optimal passive portfolio is linked to the ``expected market portfolio,'' while the optimal active portfolio has elements of value and quality investing. We make precise Samuelson's Dictum by showing that macro inefficiency is greater than micro inefficiency under realistic conditions --- in fact, all inefficiency arises from systematic factors when the number of assets is large. Further, we show how the costs of active and passive investing affect macro and micro efficiency, fees, and assets managed by active and passive managers. Our findings help explain empirical facts about the rise of delegated asset management, the composition of passive indices, and the resulting changes in financial markets.

"A Long and a Short Leg Make For a Wobbly Equilibrium"
The interaction between the spot and lending markets for stocks can lead to abrupt changes in short selling. Furthermore, rational short sellers may choose to abandon the market even as mispricing widens. The model can help explain the fat-tailed dynamics of short selling in the data, and further provides conditions identifying stocks that are more likely to experience large and abrupt changes in short selling. We verify these predictions empirically. We also apply the theory to understand curious patterns in the behavior of short sellers during one of the historically worst periods for short selling, November 2020–January 2021.