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Rising temperatures, falling ratings: the effect of climate change on sovereign creditworthiness
(2021)
How will a changing climate impact the creditworthiness of governments over the very long term? Financial markets need credible, digestible information on how climate change translates into material risks. To bridge the gap between climate science and real-world financial indicators, the authors simulate the effect of climate change on sovereign credit ratings for 108 countries, creating the world’s first climate-adjusted sovereign credit rating. The study offers a first methodological approach to extend the long-term rating to an ultra-long-term reality, aiming at long-term investors, but also regulators and rating agencies.
This study explores the implications of rising markups for optimal Mirrleesian income and profit taxation. Using a stylized model with two individuals, the main forces shaping welfare-optimal policies are analytically characterized. Although a higher profit tax has redistributive benefits, it adversely affects market competition, leading to a greater equilibrium cost-of-living. Rising markups directly contribute to a decline in optimal marginal taxes on labor income. The optimal policy response to higher markups includes increasingly relying on the profit tax to fund redistribution. Declining optimal marginal income taxes assists the redistributive function of the profit tax by contributing to the expansion of the profit tax base. This response alone considerably increases the equilibrium cost-of-living. Nevertheless, a majority of the individuals become better off with the optimal policy. If it is not possible to tax profits optimally, due, for example, to profit shifting, increasing redistribution via income taxes is not optimal; every individual is worse off relative to the scenario with optimal profit taxation.
This paper investigates the effects of a rise in interest rate and lapse risk of endowment life insurance policies on the liquidity and solvency of life insurers. We model the book and market value balance sheet of an average German life insurer, subject to both GAAP and Solvency II regulation, featuring an existing back book of policies and an existing asset allocation calibrated by historical data. The balance sheet is then projected forward under stochastic financial markets. Lapse rates are modeled stochastically and depend on the granted guaranteed rate of return and prevailing level of interest rates. Our results suggest that in the case of a sharp increase in interest rates, policyholders sharply increase lapses and the solvency position of the insurer deteriorates in the short-run. This result is particularly driven by the interaction between a reduction in the market value of assets, large guarantees for existing policies, and a very slow adjustment of asset returns to interest rates. A sharp or gradual rise in interest rates is associated with substantial and persistent liquidity needs, that are particularly driven by lapse rates.
This paper sheds light on the life insurance sector’s liquidity risk exposure. Life insurers are important long-term investors on financial markets. Due to their long-term investment horizon they cannot quickly adapt to changes in macroeconomic conditions. Rising interest rates in particular can expose life insurers to run-like situations, since a slow interest rate passthrough incentivizes policyholders to terminate insurance policies and invest the proceeds at relatively high market interest rates. We develop and empirically calibrate a granular model of policyholder behavior and life insurance cash flows to quantify insurers’ liquidity risk exposure stemming from policy terminations. Our model predicts that a sharp interest rate rise by 4.5pp within two years would force life insurers to liquidate 12% of their initial assets. While the associated fire sale costs are small under reasonable assumptions, policy terminations plausibly erase 30% of life insurers’ capital due to mark-to-market accounting. Our analysis reveals a mechanism by which monetary policy tightening increases liquidity risk exposure of non-bank financial intermediaries with long-term assets.
Risiko muss wieder kosten
(2011)
We study nominal wage rigidity in the Netherlands using administrative data, which has three key features: (1) high-frequency (monthly), (2) high-quality (administrative records), and (3) high coverage (the universe of workers and the universe of firms). We find wage rigidity patterns in the data that are similar to wage behavior documented for other European countries. In particular we find that the hazard function has two spikes, one at 12 months and another one at 24 months and wage changes have time and state dependency components. As a novel and important piece of evidence we also uncover substantial heterogeneity in the frequency of wage changes due to explicit terms of the labor contract. In particular, contracts featuring flexible hours, such as on-call contracts, exhibit a higher probability of a change in the contract wage compared to fixed hour contracts. Once we split the sample based on contract characteristics, we also find that the response of wage changes to the time and state component is heterogeneous across different type of contracts - with relatively more downward adjustments in flexible-hour contract wages in response to aggregate unemployment.
In recent years European financial regulation has experienced a tremendous reorientation with respect to the shadow banking system, which manifested first and foremost in its reframing as market-based finance. Initially identified as a source of systemic risk certain initiatives did not only fall much behind the envisaged changes but all to the contrary have been substantially modified in a way that they now aim at revitalizing these activities. The reorientation of European regulatory agency on shadow banking post-crisis, from curtailing it to facilitating resilient market-based finance, has been a cause for irritation by academic observers, dismissed by some as mere rebranding or taken as a sign of regulatory capture. All to the contrary, this paper documents the central role of regulatory agency in shadow banking’s reconfiguration. It does so by analyzing the European initiatives concerning the regulation of Asset-Backed Commercial Paper (ABCP) and another prime example of shadow banking, Money Market Mutual Funds (MMFs). Based on documentary analysis and expert interviews we trace the way the recently published EU frameworks for MMFs and ABCP have been designed (in particular the STS, CRR and MMF regulation in 2017). Furthermore, we show how they have been transformed in such a way that their final versions allow to re-establish the shadow banking chain linking MMFs, the ABCP market and arguably the regular banking system. This transformation is driven by a new form of pro-active European regulatory agency which aims at creating a regulatory infrastructure able to sustain the orderly flow of real economy debt. Far from being captured by the industry, they did so consciously and in cooperation with private actors in order to maintain a channel for credit creation outside of bank credit, a task made more complicated by the rushed politicized final negotiations coupled with technical complexity. This paper thereby contributes to a new strand of literature, seeing the creation and reconfiguration of the shadow banking system as characterized by the active and conscious role of state actors.
Revisiting the stealth trading hypothesis: does time-varying liquidity explain the size-effect?
(2019)
Large trades have a smaller price impact per share than medium-sized trades. So far, the literature has attributed this effect to the informational content of trades. In this paper, we show that this effect can arise from strategic order placement. We introduce the concept of a liquidity elasticity, measuring the responsiveness of liquidity demand with respect to changes in liquidity supply, as a major driver for a declining price impact per share. Empirical evidence based on Nasdaq stocks strongly supports theoretical predictions and shows that the aspect of liquidity coordination is an important complement to rationales based on asymmetric information.
A number of recent studies regress a "narratively" identified measure of a macroeconomic shock directly on an outcome variable. In this note, we argue that this approach can be viewed as the reduced-form regression of an instrumental variable approach in which the narrative time series is used as an instrument for an endogenous series of interest. This motivates evaluating the validity of narrative measures through the lens of a randomized experiment. We apply our framework to four recently constructed narrative measures of tax shocks by Romer and Romer (2010), Cloyne (2013), and Mertens and Ravn (2012). All of them turn out to be weak instruments for observable measures of taxes. After correcting for weak instruments, we find that using any of the considered narrative tax measures as an instrument for cyclically adjusted tax revenues yields tax multiplier estimates that are indistinguishable from zero. We conclude that the literature currently understates the uncertainty associated with quantifying the tax multiplier.