Finance Department

  • Torben Andersen
    Torben Andersen
    Nathan S. and Mary P. Sharp Professor of Finance Torben Andersen Photo © Nathan Mandell

The Kellogg School's Finance department is renowned in a broad range of specialties, from technical asset pricing to corporate financial policies and capital market dynamics. Faculty research is consistently recognized by award-winning publications in flagship finance journals. The Finance faculty also serve as editors of leading professional publications, setting the standards for new ideas in finance. The Finance major, among the most popular at the Kellogg School, takes full advantage of this expertise in a broad set of courses taught by faculty at the forefront of the field. more...

Department News

For the second year in a row, Associate Professor of Finance Dimitris Papanikolaou won the Amundi Smith Breeden Award for best paper in the Journal of Finance. Learn more about the prize and his research at Kellogg Insight.

Kellogg Insight presents articles on Finance

How Malls Die—and How Your Business Could Be Next: When retail-store locations go under, they drag nearby stores down too

The global financial crisis of 2008 might not appear to have much in common with a derelict shopping mall in your neighborhood. But both are examples of how financial distress can spread through markets like a contagious disease. Unlike global financial markets, the retail stores in a mall are primarily connected via their physical proximity to one another—a phenomenon that economists call “retail agglomeration.” But the connections within these local, brick-and-mortar “networks” can propagate economic shocks just as powerfully as the virtual networks that connected Lehmann Brothers and Goldman Sachs. And just as the failure of one investment bank started a domino effect that threatened its peers and competitors around the globe, the bankruptcy of a large retail location in a mall or shopping center puts neighboring stores at increased risk of failure as well.

Even if the local economic conditions are otherwise good, the loss of a single retail tenant exposes every other store around it to a potential cascade of ill economic outcomes.

Safety in Numbers

This effect is identified by economist Efraim Benmelech in the paper “The Agglomeration of Bankruptcy.” Benmelech, who directs the Guthrie Center for Real Estate Research at Northwestern University’s Kellogg School of Management, acknowledges that so-called “agglomeration economies” have been a feature of retail markets since long before any shopping malls existed. “In the diamond district in New York City, stores sell almost exactly the same thing right next to each other. And in the Grand Bazaar in Istanbul, the spice and textile stores are all on the same streets,” he explains. “This is a very old phenomenon.”

For good reason: historically, customers rarely have perfect information about what is on offer in a market. So the purpose of a physical market is not just to retail goods to customers, but to provide a convenient context for customers to learn about what they can buy. “They want to shop from several stores to acquire this information in one trip,” Benmelech explains. “So it makes sense for specialized stores to colocate next to each other, even if they are competitors.”

Domino Effects

The economic benefits of retailers’ physical agglomeration are obvious to anyone who has visited a shopping mall intending to purchase one item and found himself coming home with ten. But agglomeration economies are a double-edged sword. “What are the negative consequences of breaking this link between stores? And what is happening to the neighboring stores when a store shuts down?” Benmelech says. “When several stores leave the mall, that makes it less attractive to consumers, which weakens the position of the remaining stores. It’s a domino effect, and basically the mall dies. We wanted to evaluate that.”

This mechanism for “mall death” appears straightforward, but empirically proving a causal link—that the bankruptcy of one store actually causes the financial distress of its neighbors, rather than merely coincides with it—has been difficult. For example, the deterioration of a shopping center could be caused by declining local economic conditions, which would affect all the “agglomerated” stores in a certain location.

Benmelech and his collaborators were able to rule out this possibility by focusing on national retail chains that went out of business between 2005 and 2010 (including Circuit City, The Sharper Image, and Linens ‘n Things). Because these firms closed all their store locations in the United States simultaneously, the researchers could reasonably assume that any failures of neighboring stores “had nothing to do with local conditions or declining demand,” Benmelech explains.

Instead, “we show a domino effect where a negative shock to a retail environment, driven by the fact that some players are leaving the area, is leading to further economic deterioriation in that area. Stores would like to be next to each other, and consumers would like to go to malls with high occupancy rates. When this breaks down, it means that more and more stores close, which leads to a local economic decline.”

In addition, as you might expect, the researchers find that, in the wake of a closing national chain store, neighboring stores are more affected by the negative shock if they are less profitable. For example, any store within 50 meters of a bankrupt chain location would be at a higher risk of closing its own doors—but if that neighboring store were in just the 25th percentile of profitability, its odds of closing increase by 16.9 to 22.2 percent.

Shoring Up Defenses

This analysis can make bankruptcy agglomeration sound like a force of nature, wrecking stores based on location and blind chance the same way a tornado or earthquake might. Benmelech does not disagree, but he adds that increased awareness of the risk can still empower retail real-estate players. Mall and shopping-center owners, for example, would do well to carefully examine the financial stability of their larger tenants, because the failure of one of these “anchors” could threaten everyone else. Understanding how bankruptcy agglomeration works could also help those owners unlucky enough to experience it mitigate or even reverse its effects. “It may make sense to bring in a new tenant and offer him a very low lease, or even pay the tenant to come in order to stabilize the mall,” Benmelech says. “It may seem counterintuitive, but you will pay much more if you lose your other tenants.”

And as other sectors of the global economy become ever more integrated and networked, Benmelech adds, the lessons of bankruptcy agglomeration may apply far beyond the realm of retail. In a world of hyperconnected markets—both physically and virtually—some of our most basic business intuitions may need to be revised. “You’d think that if your neighbor closes their store, that’s good news because you can get their business,” Benmelech says. “But what we’ve shown is a nontrivial and nonintuitive lesson: it's not always true that I would like my competitor to fail.”

Editor’s Note: "The Agglomeration of Bankruptcy" will soon be published as part of the Guthrie Center for Real Estate Research Working Paper Series.

Artwork by Yevgenia Nayberg

Is Economic Growth a Question of Culture?: A decade of research shows how culture seeps into economic decisions

As some countries’ economies churn steadily—even briskly—over time, others’ remain stagnant. While standard economic variables, such as productivity and availability of capital, explain international differences, some of these differences remain unexplained. Gaps in economic development often seem to fall along cultural lines. “Culture and economics, they move together,” says Paola Sapienza, a professor of finance at the Kellogg School. But does culture follow economic development or is economic development directed by culture?

The debate goes all the way back to Karl Marx, who held the view that everything is driven by economics. Marx deemed religion, for instance, the opium of the people—imposed by, and to the benefit of, the economic establishment. But another view, held by Max Weber, gave culture more credence. Parts of Europe developed earlier and stronger than others, he posited, due to the influence of Protestant work ethics.

Who is right? Economists have traditionally taken the Marxian view, says Sapienza—at least until recently.

A Trip to Europe

Until just a few generations ago, living arrangements were very similar in Northern and Southern Europe. But more recently, the differences have become starker. In Southern Europe, children tend to live at home much longer than in Northern Europe. “This has enormous consequences,” explains Sapienza. “If they live at home until they’re forty, they have fewer children. We know that demographic growth is very, very important for economic growth, and so the question is: Why is there this big difference?”

The economic explanation, of course, is that, with unemployment high and real estate expensive in Southern Europe, kids simply cannot afford to move out. This is a “perfectly reasonable” explanation, says Sapienza, and proves that the economics “explains” cultural norms.

But there’s another possibility. The sexual revolution, which crashed through the Western world beginning in the 1960s, has changed the mores around children living at home. Before, the desire to enter into a serious relationship may have prodded more people out of the house at an early age. Now, it is no longer necessary to experience independence outside your parents’ home. Today, with no such pressure—as well as a free place to stay, complete with home-cooked meals and laundry service, at least in the nurturing family environment of Southern Europe—one wonders whether adult children even have a reason to leave the house. Culture may well be driving economic growth.

Taking Culture with You

Successfully disentangling the relationship between culture and economics has rested on one key truth: visitors to a new country inevitably bring some of their old cultural traditions with them. In 1997, for instance, a man and a woman left their 14-month-old child unattended outside of a New York City barbeque joint while they ate. Passersby noted the toddler crying in her stroller and called the police, who charged the parents with endangering the welfare of a child. The arrest raised a ruckus in the parents' native Denmark, where it is commonplace to leave babies outside of restaurants and shops while parents go about their business.

Other habits—including more economically relevant ones, like a willingness to conform to rules—also travel across borders. In 2006, economist Ray Fisman tallied up the parking tickets given to United Nations diplomats. Because diplomats have diplomatic immunity and need never pay up, the only reason they would not park illegally is if they have internalized a cultural norm that tells them not to break the rules. Indeed, Fisman found that diplomats from highly corrupt countries tended to rack up more tickets than those from nations with low levels of corruption.

Economists have been able to exploit our tendency to take our culture with us by studying the economic habits of immigrants and their families. “In a way, with immigrants, you almost have a natural experiment,” says Sapienza. “It’s not perfect because, of course, immigrants self-select. But you have these people who are away from their environment.”

And just how they behave in a new country offers strong evidence that culture is often independent from economic context and may, in turn, play a causal role in shaping economics. Immigrants seem to keep the savings habits they’ve acquired in their old countries, for instance. And even their children tend to make labor and fertility choices that mirror those of children born in the country of origin. Indeed, in the study of living arrangements, UCLA economist Paola Giuliano showed that the sons and daughters of first-generation immigrants to the United States behave according to the geographical divide in Europe: southern European immigrants more frequently live at home with their parents, while those from northern Europe tend to live independently early on. This is remarkable because these immigrants are placed in the same economic context, yet their culture affects their decisions. 

Trust and Economics

Acknowledging that cultural attitudes can influence economic decisions raises a question: Which attitudes? Over the years, the bulk of Sapienza’s own research has focused on trust. “My view has always been that trust is one variable that is highly cultural, often transmitted from parents to kids,” she says. “Think about the recommendation in some cultures not to trust anybody.” Growing up in an environment where you are told not to talk to strangers or rely on government officials sets you up to expect the worst from every encounter with a person or the state—and behave accordingly.

The economic implications of low trust can be vast. “Trust is quintessentially one of the most important ingredients in economic transactions,” says Sapienza. Sure, we can—and should—write contracts. But no contract will cover every contingency. “You have to trust the person you’re negotiating with that eventually we’re going to work together to work things out,” says Sapienza. “While trust is fundamental to all trade and investment, it is particularly important in financial markets, where people part with their money in exchange for promises.”

Trust levels differ wildly from one country to another. In Brazil, it is very low; in Northern European countries, it is much higher. And trust is strikingly persistent. This is partly just a common sense reaction to reality: if you live in a low-trust society, “it’s optimal for you to teach your kids not to trust,” says Sapienza, “because if you’re the only one trusting, you’re very likely going to be surprised by somebody taking advantage of you. In a culture where everyone is trusting, and there is therefore more cooperative behavior, the optimal thing to teach your kids is indeed to trust others. This transmission of cultural attitudes may have big economic consequences.”

Living without Trust

Sapienza has found that people tend to write fewer financial contracts in areas where the level of trust is lower. This unsurprisingly has a negative impact on economic development. “You have worse financial allocation,” says Sapienza, “because the quintessential mechanism of a free market economy is that people who have the capital are not necessarily the people who have the ideas. In order to put capital to use, you really have to make it circulate.”

Another of Sapienza’s studies finds that just how much citizens of one European country trust those of another impacts their willingness to engage in mutually beneficial financial transactions. Countries that do not share a national religion, have a history of war with each other, have fewer genetic similarities, or even simply possess negative stereotypes about each other are less likely to trade and invest in each other.

But trust does not just differ from nation to nation. In yet another study, Sapienza and her colleagues find that even within a state, individuals who are more trusting have riskier stock market portfolios: “People who believe that others can be trusted in general … end up putting their money to work,” says Sapienza, “investing in the stock market more, investing in riskier assets, and eventually having a higher return.”

Persistence of Growth

Sapienza believes that relatively high levels of trust in Northern Italy—and elsewhere in the world—stem from historical precedent. Back in the Middle Ages, many cities in Northern Italy, unlike many similar ones in the South, “rebelled against the Emperor and became free city states,” she explains. The undertaking required enormous cooperation among various parties and resulted in a much more open, transparent style of government. “What we claim in [a recent] paper is that this experience has led people to trust that they can change things,” says Sapienza. Today, Italian cities that became free city states over 800 years ago have more nonprofit organizations, engage in more blood and organ donation, and raise children less likely to cheat on their national exams than those that did not. That history begets culture is not an entirely new idea. Nathan Nunn, a professor at Harvard University, finds that even today low levels of trust in some regions of Africa align closely with regions where slave trade caused the most damage.

But perhaps history need not be destiny. Sapienza and other economists would like to find ways to increase trust levels in regions where they have historically been low—particularly in places where barriers to economic development, such as legalized discrimination, have since been removed.  But change will not come easily. “Where do we start?” Sapienza asks. “If you don’t trust anybody, you will not engage in transactions and, of course, the system will not reward you, even when institutional changes have removed discrimination. More importantly, if you don’t trust, you’re going to teach your kids not to trust, which creates a cycle that is difficult to escape.”

Artwork by Yevgenia Nayberg

The Hidden Benefits of Unemployment Insurance: A pioneering study reveals that the benefits of unemployment insurance include reductions in mortgage defaults and improved access to credit

Unemployment insurance (UI) is the third-largest government program for transferring funds to the needy, behind only Social Security and government-sponsored health care. Though the program is sometimes criticized for reducing the motivation to find work, over the years economists have attributed a number of social benefits to it. UI provides the recently unemployed with the means to buy groceries, gas, and clothing, driving up overall consumer spending, which can be particularly helpful in a recession. It also provides job seekers with the resources to pass up less desirable opportunities while hunting for the right position.

Recent research by a team that included two Kellogg School of Management professors suggests that UI’s social benefits extend much further than previously believed. The expansion of UI “played an important role in preventing foreclosures during the Great Recession,” says Brian Melzer, an assistant professor of finance. Melzer and David Matsa, an associate professor of finance, collaborated on the study with Joanne Hsu of the Federal Reserve Board of Governors in Washington, D.C.

The researchers estimate that between 2008 and 2012, the program helped to avert $70 billion in social costs from foreclosures, including depreciation in the foreclosed properties’ structural values, decline in neighboring home values, and transaction costs paid by lenders and households. In addition, the expansion improved access to credit for a broad swath of poor individuals, including people who never had to draw on the insurance. In a broader sense, the study argues for the effectiveness of public policies like unemployment insurance that improve people’s ability to pay off their debts, as opposed to merely improving their incentive to pay them off.

Income Risk and Default

The research project started with the intuitive feeling that, as Melzer explains, “reducing household income risk would reduce default.” However, he continues, “it was uncertain how big the effect would be.” When the research began, nobody had yet investigated the link between mortgage default and workers’ job histories. Making that connection enabled the researchers to provide new insights.

To determine the extent of the relationship between income risk and default, the researchers used the fact that the level of unemployment insurance varies among states. In the basic program, unemployed individuals can receive half of their income for up to six months if they haven’t found a job. But the weekly benefit is subject to a cap. As a result, the total benefits currently available range from $6,000 in Mississippi to $28,000 in Massachusetts. In response to the Great Recession, the federal government helped states offer extra payments, with amounts dependent in part on those states’ unemployment rates. The government provided extra funding that increased the duration of UI—for example, in the time period the researchers studied, recipients qualified for 20 additional weeks of benefits totaling up to $6,000 in South Dakota but 53 additional weeks of benefits worth up to $31,000 in New Jersey. The researchers then tracked mortgage delinquency trends for employed and unemployed households between 1991 and 2011, matching them to these differences across states.

Implications for Housing Policy

The results show a significant correlation between UI and improved financial circumstances for individuals. The impact on housing proves surprisingly large. An increase of $3,600 in a state’s maximum regular UI benefits prevents 15% of the average mortgage delinquencies caused by layoffs. Over the long term, that serves to reduce foreclosures among unemployed homeowners. “These effects are sizable,” the team writes. “[T]he increase in evictions, a subset of defaults, associated with being laid off is cut almost in half.”


[The figures below show the relationship between the maximum amount of extended UI benefits a household is eligible to receive in a given state and the percentage of delinquent mortgagors in that state (as of May 2009). As maximum UI increases, delinquent mortgages decrease—but only among households that experienced unemployment.]

Households Experiencing Unemployment

Households Experiencing No Unemployment


The impact applies even to mortgage holders who owed significantly more than the value of their houses. “A policy like UI that improves a household’s ability to repay debt is effective even for households deeply in debt and underwater on their mortgages,” Melzer says. That is, even the households with the greatest incentive to strategically default are more likely to stay in their homes.

Intriguingly, UI provides mortgage relief more effectively than programs dedicated to that goal, such as the Home Affordable Refinance Program and the Home Affordable Modification Program. It does so, the team explains, by transferring money directly to homeowners, bypassing lenders and loan services. “We’re not saying that UI is the perfect policy to prevent mortgage foreclosures. Half of UI recipients rent or have no mortgage. But the effect—avoiding 1.4 million foreclosures—is too big to be ignored,” Matsa says.

In addition to the social benefits of avoiding the foreclosures, these effects also reduced the cost of providing UI to households in need. That’s because the federal government effectively guarantees many mortgage payments through Fannie Mae and Freddie Mac, allowing money saved by preventing foreclosures to essentially offset some of the money spent on UI. “We estimate that avoiding foreclosures reduced the cost of extending UI during the Great Recession by about 20 percent,” Matsa says.

Beyond Housing

But the benefits of UI are not restricted to the unemployed—or for that matter, their neighbors, communities, and lenders. By reducing the likelihood that unemployed borrowers would default, unemployment insurance has an additional consequence: It improves the creditworthiness of individuals at risk of being laid off.

By analyzing mortgages, home equity lines of credit, and credit card loans, the researchers were able to determine that households—even those experiencing no loss of employment—enjoy expanded access to credit, including lower interest rates and higher credit limits. Overall, interest rates decline by 1.4 percent and credit limits jump by $1,700 for every $3,600 increase in maximum UI benefits. For households earning less $35,000 a year, the decrease in interest rates and increase in credit limits are substantially greater.

The study suggests that, despite the costs of implementing and expanding UI, the program provides even broader societal value than previously understood. Policy makers should keep these benefits in mind as they consider programs that offer direct financial assistance to individuals looking to get back in the black. “Because costs spill over from housing default, our findings show that UI benefits the neighbors of the unemployed and the financial system overall,” Melzer says. “You don’t have to lose your job to benefit from unemployment insurance,” Matsa adds. “People often benefit from social insurance even if they never draw a payment.”

Artwork by Yevgenia Nayberg

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