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We examine whether the economy can be insured against banking crises with deposit and loan contracts contingent on macroeconomic shocks. We study banking competition and show that the private sector insures the banking system through such contracts, and banking crises are avoided, provided that failed banks are not bailed out. When risks are large, banks may shift part of them to depositors. In contrast, when banks are bailed out by the next generation, depositors receive non-contingent contracts with high interest rates, while entrepreneurs obtain loan contracts that demand high repayment in good times and low repayment in bad times. As a result, the present generation overinvests, and banks generate large macroeconomic risks for future generations, even if the underlying productivity risk is small or zero. We conclude that a joint policy package of orderly default procedures and contingent contracts is a promising way to reduce the threat of a fragile banking system.
We study the interplay of capital and liquidity regulation in a general equilibrium setting by focusing on future funding risks. The model consists of a banking sector with long-term illiquid investment opportunities that need to be financed by shortterm debt and by issuing equity. Reliance on refinancing long-term investment in the middle of the life-time is risky, since the next generation of potential short-term debt holders may not be willing to provide funding when the return prospects on the long-term investment turn out to be bad. For moderate return risk, equilibria with and without bank default coexist, and bank default is a self-fulfilling prophecy. Capital and liquidity regulation can prevent bank default and may implement the first-best. Yet the former is more powerful in ruling out undesirable equilibria and thus dominates liquidity regulation. Adding liquidity regulation to optimal capital regulation is redundant.
Why bank money creation?
(2022)
We provide a rationale for bank money creation in our current monetary system by investigating its merits over a system with banks as intermediaries of loanable funds. The latter system could result when CBDCs are introduced. In the loanable funds system, households limit banks’ leverage ratios when providing deposits to make sure they have enough “skin in the game” to opt for loan monitoring. When there is unobservable heterogeneity among banks with regard to their (opportunity) costs from monitoring, aggregate lending to bank-dependent firms is inefficiently low. A monetary system with bank money creation alleviates this problem, as banks can initiate lending by creating bank deposits without relying on household funding. With a suitable regulatory leverage constraint, the gains from higher lending by banks with a high repayment pledgeability outweigh losses from banks which are less diligent in monitoring. Bank-risk assessments, combined with appropriate risk-sensitive capital requirements, can reduce or even eliminate such losses.
A number of authors have recently emphasized that the conventional model of unemployment dynamics due to Mortensen and Pissarides has difficulty accounting for the relatively volatile behavior of labor market activity over the business cycle. We address this issue by modifying the MP framework to allow for staggered multiperiod wage contracting. What emerges is a tractable relation for wage dynamics that is a natural generalization of the period-by-period Nash bargaining outcome in the conventional formulation. An interesting side-product is the emergence of spillover effects of average wages on the bargaining process. We then show that a reasonable calibration of the model can account well for the cyclical behavior of wages and labor market activity observed in the data. The spillover effects turn out to be important in this respect. JEL Classification: E32, E50, J64
We study the role of various trader types in providing liquidity in spot and futures markets based on complete order-book and transactions data as well as cross-market trader identifiers from the National Stock Exchange of India for a single large stock. During normal times, short-term traders who carry little inventory overnight are the primary intermediaries in both spot and futures markets, and changes in futures prices Granger-cause changes in spot prices. However, during two days of fast crashes, Granger-causality ran both ways. Both crashes were due to large-scale selling by foreign institutional investors in the spot market. Buying by short-term traders and cross-market traders was insufficient to stop the crashes. Mutual funds, patient traders with better trade-execution quality who were initially slow to move in, eventually bought sufficient quantities leading to price recovery in both markets. Our findings suggest that market stability requires the presence of well-capitalized standby liquidity providers.
Extant research shows that CEO characteristics affect earnings management. This paper studies how investors infer a specific characteristic of CEOs, namely moral commitment to honesty, from earnings management and how this perception – in conjunction with their own social and moral preferences – shapes their investment choices. We conduct two laboratory experiments simulating investment choices. Our results show that participants perceive a CEO to be more committed to honesty when they infer that the CEO engaged less in earnings management. For investment decisions, a one standard deviation increase in a CEO's perceived commitment to honesty compared to another CEO reduces the relevance of differences in the CEOs’ claimed future returns by 40%. This effect is most prominent among investors with a proself value orientation. To prosocial investors, their own honesty values and those attributed to the CEO matter directly, while returns play a secondary role. Overall, perceived CEO honesty matters to different investors for distinct reasons.
We study how the informativeness of stock prices changes with the presence of high-frequency trading (HFT). Our estimate is based on the staggered start of HFT participation in a panel of international exchanges. With HFT presence, market prices are a less reliable predictor of future cash flows and investment, even more so for longer horizons. Further, firm-level idiosyncratic volatility decreases, and the holdings and trades by institutional investors deviate less from the market-capitalization weighted portfolio as a benchmark. Our results document that the informativeness of prices decreases subsequent to the start of HFT. These findings are consistent with theoretical models of HFTs' ability to anticipate informed order flow, resulting in decreased incentives to acquire fundamental information.
We examine trust and trustworthiness of individuals with varying professional preferences and experiences. Our subjects study business and economics in Frankfurt, the financial center of Germany and continental Europe. In the trust game, subjects with a high interest in working in the financial industry return 25 percent less than subjects with a low interest. We find no evidence that the extent of professional experience in the financial industry has a negative impact on trustworthiness. We also do not find any evidence that the financial industry screens out less trustworthy individuals in the hiring process. In a prediction game that is strategically equivalent to the trust game, the amount sent by first-movers was significantly smaller when the second-mover indicated a high interest in working in finance. These results suggest that the financial industry attracts less trustworthy individuals, which may contribute to the current lack of trust in its employees.
Improving financial conditions of individuals requires an understanding of the mechanisms through which bad financial decision-making leads to worse financial outcomes. From a theoretical point of view, a key candidate inducing mistakes in financial decision-making are so called present-biased preferences, which are one of the cornerstones of behavioral economics. According to theory, present-biased households should behave systematically different when it comes to consumption and saving decisions, as they should be more prone to spending too much and saving too little.
In this policy letter we show how high frequency financial transaction data available in digitized form allows to precisely categorize individual financial-decision making to be present-biased or not. Using this categorization, we find that one out of five individuals in our sample exhibits present-bias and that this present-biased behavior is associated with a stronger use of overdrafts. As overdrafts represent a particularly expensive way of short-term borrowing, their systematic use can be interpreted as a measure of suboptimal financial-decision making. Overall, our results indicate that the combination of economic theory and Big Data is able to generate valuable insights with applications for policy makers and businesses alike.
Sondierungsstudie im Auftrag des Bundesministeriums für Bildung und Forschung: Die jüngste Finanzkrise und die darauf folgende Staatsschuldenkrise hat sowohl wirtschaftlich als auch gesellschaftlich tiefgreifende Spuren hinterlassen. Dabei wurden auch sehr deutliche Lücken in der Forschung offenbar. Ziel dieser Studie ist es, aufbauend auf dem aktuellen Forschungsstand weiteren Forschungsbedarf in den wesentlich mit Finanzkrisen verbundenen Bereichen aufzuzeigen. Es werden fünf Forschungsbereiche mit jeweiligen Unterthemen vorgeschlagen. Diese fünf Forschungsbereiche gehen unmittelbar aus der Struktur und den Mechanismen der Finanz- und Staatsschuldenkrise hervor. Dabei wird besonderes Augenmerk auf die wirtschafts- und regulierungspolitische Relevanz der Themen sowie dem Umstand getragen, dass die Beantwortung vieler der Fragen interdisziplinäre Zusammenarbeit erfordert.
Finanzkrisen sind inherent mit dem Bankenmodell verbunden. Aufgrund von Verbindungen der Banken untereinander können Probleme einzelner Institute auf andere Institute übertragen werden. Diese systemischen Risiken können das gesamte Finanzsystem destabilisieren. Das Finanzsystem nimmt durch die Kreditvergabe und Bereitstellung von Transaktionssystemen eine herausragende Stellung in einer Volkswirtschaft ein, wodurch stabilisierende Eingriffe der Politik notwendig werden können. Eingriffe zur Wiederherstellung von Stabilität können sehr kostspielig sein und, wie aktuell eindrucksvoll belegt, die stabilisierenden Staaten selbst destabilisieren. Die alternativen Eingriffe vorab betreffen neben der Geldpolitik vor allem regulatorische Eingriffe. Im besonderen sind die Corporate Governance von Finanzinstituten und die Informationsbereitstellung bzw. Transparenz innerhalb des Finanzsektors von Bedeutung. In den vergangen Jahren wuchs vor dem Hintergrund von Regulierung zudem ein paralleles Schattenbankensystems heran, das in seiner Bedeutung dem traditionellen Bankensystem nur unwesentlich nachsteht.
Zwar sind die groben Zusammenhänge und Auswirkungen in den einzelnen Bereichen bekannt, jedoch ist für ein tiefgreifendes Verständnis als Grundlage zur Vermeidung bzw. Eindämmung zukünftiger Krisen sowie zur Folgenabschätzung von Regulierung weitere Forschung unabdingbar.