Manav Chaudhary

Regulator Beliefs

Financial regulations embed views on the behavior of economic and financial variables, which I term regulator beliefs. Using the life insurance setting, I develop new methods to measure regulator and firm beliefs. Regulator interest rate expectations are extracted from the regulator's economic model prescribed for risk-based capital and policy reserve calculations, and insurer expectations are extracted from investor call transcripts using a large language model. Using this novel data, I document four facts. First, regulator expectations, despite systematic errors, outperform professional forecasters. Second, regulators and insurers significantly disagree on future yields. Third, regulators, though more accurate than insurers, make more updating errors, like underreacting to new information. Fourth, regulator expectations cause insurers to adjust the expectations they communicate to investors, highlighting the need to consider the regulatory environment when interpreting institutional investors' reported beliefs. I then confirm that regulator beliefs drive regulated firm decisions. Using two quasi-experiments, I demonstrate that insurers significantly rebalance their bond portfolios to align with regulator beliefs, even when belief changes arise from completely arbitrary factors. Finally, using Federal Reserve stress tests, I illustrate the broader relevance of regulator beliefs by showing that banks adjust capital allocations in response to shifts in Fed beliefs. Given the omnipresent role of regulator beliefs in modern regulatory frameworks for banks, insurers, and pension funds, my findings lay the groundwork for a broader research agenda connecting regulator beliefs to financial institution decisions, asset prices, and financial stability.

Corporate Bond Multipliers: Substitutes Matter
R&R at  Review of Financial Studies
(with Zhiyu Fu and Jian Li)

Many economic questions require estimating the price impact of demand shifts (multipliers) in the bond market. Corporate bonds have salient characteristics that distinguish close versus distant substitutes. We show that accounting for the heterogeneous substitutability between bonds is critical for estimating multipliers correctly. By allowing for heterogeneous substitution, we find that security-level multipliers are essentially zero—an order of magnitude smaller than the estimate ignoring heterogeneous substitutability. Nonetheless, portfolio multipliers are substantially larger and monotonically increase with the aggregation level. Furthermore, we find that the multiplier is larger for high-yield bonds, longer-maturity bonds, and bonds with greater arbitrage risks.

• Presentations: AFA 2024, AFFECT 2023, Columbia Business School, EFA 2024, EPFL, HKUST, LBS's TADC, MFA 2024, NBER SI Asset Pricing 2023, UCLA's David Backus Memorial Conference, University of Chicago, University of Minnesota, and Yiran Fan Memorial Conference

• Awards: TADC’s AQR Asset Management Institute Prize for best economics paper

Inflation Expectations and Stock Returns
(with Ben Marrow)

How do inflation expectations affect stock returns, and what accounts for this relationship? We directly measure investors' expectations using traded inflation-indexed contracts and show that, post-2000, stocks offer positive returns in response to higher expected inflation: unconditionally, a 10 basis point increase in 10-year breakeven inflation is associated with a 1.1% increase in the value-weighted stock index. Using a wide range of approaches, we show that this positive relationship is almost entirely due to aggregate variations in expected excess returns rather than changes in firm cash flows (e.g., due to higher mark-ups) or fluctuations in risk-free rates (e.g., due to expected monetary policy response). Overall, a risk premium “proxy” mechanism appears to explain this dominant role of expected excess returns: higher long-term inflation expectations signal stronger future economic growth and reduced volatility.

• Presentations: LBS's TADC, University of Chicago, Yiran Fan Memorial Conference (poster), CCSRG, Inter-finance PhD Seminar

• Awards: TADC’s AQR Asset Management Institute prize for best finance paper, Yiran Fan Memorial prize for best third year paper 

Anatomy of the Treasury Market: Who Moves Yields?
(with Zhiyu Fu and Haonan Zhou)

We develop a quantity-based framework to study the drivers of U.S. Treasury yields. Our method allows for flexible identification of price and factor sensitivities for heterogeneous investors in a demand-supply model using granular idiosyncratic shocks. Overall, a 1 percent demand increase for U.S. Treasury notes and bonds results in a 1 percent increase in prices, equivalent to a 10 basis points decline for the ten-year yield. We uncover substantial heterogeneity across investors and regimes in sectors' sensitivity to Treasury yield changes and aggregate factors. Using the estimated model, we decompose changes in Treasury yields over the past two decades, and document three main findings: (i) Contrasting to the conventional wisdom, foreign investors contribute little to Treasury price appreciation during flight-to-safety episodes; (ii) U.S. banks and foreign investors becomes more price insensitive after the global financial crisis, while the Federal Reserve has stepped up its role as a state-contingent liquidity provider; (iii) while major foreign Treasury holders are the biggest contributor to Treasury yield compression before the financial crisis, the influence of foreign demand on Treasury yields has substantially weakened since 2010.

Regulator Belief Induced Minsky Cycles

Model-based constraints have become the dominant method for regulating intermediaries. These regulations require regulating model assumptions, which embed regulator beliefs about economic and financial variables into firm constraints. However, these regulator beliefs exhibit systematic biases, and due to their ability to coordinate firm decisions through intermediary constraints, they can amplify systemic risk (Chaudhary, 2024). This paper introduces regulator belief–dependent constraints in a Brunnermeier and Sannikov (2014) macrofinance model to study the systemic risk implications of such regulations. The model exhibits procyclical leverage and generates endogenous Minsky Cycles driven by regulators learning from recent data. During prolonged periods of stability, the regulator revises down their risk assessment, which relaxes intermediary constraints and endogenously amplifies risks. In times of crisis, elevated regulator risk assessment leads to tighter constraints, exacerbating the procyclicality of leverage and prolonging crisis episodes. Nevertheless, regulation induces less risk-taking by intermediaries compared to an economy without regulation, mitigating the severity of crises overall—resulting in more frequent but less severe crises.