Center for Financial Studies (CFS)
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Motivated by the observation that survey expectations of stock returns are inconsistent with rational return expectations under real-world probabilities, we investigate whether alternative expectations hypotheses entertained in the asset pricing literature are consistent with the survey evidence. We empirically test (1) the notion that survey forecasts constitute rational but risk-neutral forecasts of future returns, and (2) the notion that survey fore- casts are ambiguity averse/robust forecasts of future returns. We find that these alternative hypotheses are also strongly rejected by the data, albeit for different reasons. Hypothesis (1) is rejected because survey return forecasts are not in line with risk-free interest rates and because survey expected excess returns are predictable. Hypothesis (2) is rejected because agents are not al- ways pessimistic about future returns, instead often display overly optimistic return expectations. We speculate as to what kind of expectations theories might be consistent with the available survey evidence.
We analytically characterize optimal monetary policy for an augmented New Keynesian model with a housing sector. In a setting where the private sector has rational expectations about future housing prices and inflation, optimal monetary policy can be characterized without making reference to housing price developments: commitment to a 'target criterion' that refers to inflation and the output gap only is optimal, as in the standard model without a housing sector. When the policymaker is concerned with potential departures of private sector expectations from rational ones and seeks to choose a policy that is robust against such possible departures, then the optimal target criterion must also depend on housing prices. In the empirically realistic case where housing is subsidized and where monopoly power causes output to fall short of its optimal level, the robustly optimal target criterion requires the central bank to 'lean against' housing prices: following unexpected housing price increases, policy should adopt a stance that is projected to undershoot its normal targets for inflation and the output gap, and similarly aim to overshoot those targets in the case of unexpected declines in housing prices. The robustly optimal target criterion does not require that policy distinguish between 'fundamental' and 'non-fundamental' movements in housing prices.
In the secondary art market, artists play no active role. This allows us to isolate cultural influences on the demand for female artists’ work from supply-side factors. Using 1.5 million auction transactions in 45 countries, we document a 47.6% gender discount in auction prices for paintings. The discount is higher in countries with greater gender inequality. In experiments, participants are unable to guess the gender of an artist simply by looking at a painting and they vary in their preferences for paintings associated with female artists. Women's art appears to sell for less because it is made by women.
We investigate the characteristics of infrastructure as an asset class from an investment perspective of a limited partner. While non U.S. institutional investors gain exposure to infrastructure assets through a mix of direct investments and private fund vehicles, U.S. investors predominantly invest in infrastructure through private funds. We find that the stream of cash flows delivered by private infrastructure funds to institutional investors is very similar to that delivered by other types of private equity, as reflected by the frequency and amounts of net cash flows. U.S. public pension funds perform worse than other institutional investors in their infrastructure fund investments, although they are exposed to underlying deals with very similar project stage, concession terms, ownership structure, industry, and geographical location. By selecting funds that invest in projects with poor financial performance, U.S. public pension funds have created an implicit subsidy to infrastructure as an asset class, which we estimate within the range of $730 million to $3.16 billion per year depending on the benchmark.
We examine how a firms' investment behavior affects the investment of a neighboring firm. Economic theory yields ambiguous predictions regarding the direction of firm peer effects and consistent with earlier work, we find that firms display similar investment behavior within an area using OLS analysis. Exploiting time-variation in the rise of U.S. states' corporate income taxes and utilizing heterogeneity in firms' exposure to increases in corporate income tax rates, we identify the causal impact of local firms' investments. Using this as an instrumental variable in a 2SLS estimation, we find that an increases in local firms' investment reduces the investment of a local peer firm. This effect is more pronounced if local competition among firms is stronger and supports theories that firm investments are strategic substitutes due to competition.
This paper analyses whether the post-crisis regulatory reforms developed by global-standard-setting bodies have created appropriate incentives for different types of market participants to centrally clear Over-The-Counter (OTC) derivative contracts. Beyond documenting the observed facts, we analyze four main drivers for the decision to clear: 1) the liquidity and riskiness of the reference entity; 2) the credit risk of the counterparty; 3) the clearing member’s portfolio net exposure with the Central Counterparty Clearing House (CCP) and 4) post trade transparency. We use confidential European trade repository data on single-name Sovereign Credit Derivative Swap (CDS) transactions, and show that for all the transactions reported in 2016 on Italian, German and French Sovereign CDS 48% were centrally cleared, 42% were not cleared despite being eligible for central clearing, while 9% of the contracts were not clearable because they did not satisfy certain CCP clearing criteria. However, there is a large difference between CCP clearing members that clear about 53% of their transactions and non-clearing members, even those that are subject to counterparty risk capital requirements, that almost never clear their trades. Moreover, we find that diverse factors explain clearing members’ decision to clear different CDS contracts: for Italian CDS, counterparty credit risk exposures matter most for the decision to clear, while for French and German CDS, margin costs are the most important factor for the decision. Clearing members use clearing to reduce their exposures to the CCP and largely clear contracts when at least one of the traders has a high counterparty credit risk.
A tale of one exchange and two order books : effects of fragmentation in the absence of competition
(2018)
Exchanges nowadays routinely operate multiple, almost identically structured limit order markets for the same security. We study the effects of such fragmentation on market performance using a dynamic model where agents trade strategically across two identically-organized limit order books. We show that fragmented markets, in equilibrium, offer higher welfare to intermediaries at the expense of investors with intrinsic trading motives, and lower liquidity than consolidated markets. Consistent with our theory, we document improvements in liquidity and lower profits for liquidity providers when Euronext, in 2009, consolidated its order ow for stocks traded across two country-specific and identically-organized order books into a single order book. Our results suggest that competition in market design, not fragmentation, drives previously documented improvements in market quality when new trading venues emerge; in the absence of such competition, market fragmentation is harmful.
We propose a spatiotemporal approach for modeling risk spillovers using time-varying proximity matrices based on observable financial networks and introduce a new bilateral specification. We study covariance stationarity and identification of the model, and analyze consistency and asymptotic normality of the quasi-maximum-likelihood estimator. We show how to isolate risk channels and we discuss how to compute target exposure able to reduce system variance. An empirical analysis on Euro-area cross-country holdings shows that Italy and Ireland are key players in spreading risk, France and Portugal are the major risk receivers, and we uncover Spain's non-trivial role as risk middleman.
With a notional amount outstanding of more than USD 500 trillion, the market for OTC derivatives is of vital importance for global financial stability. A growing proportion of these contracts are cleared via central counterparties (CCPs), which means that CCPs are gaining in importance as critical financial market infrastructures. At the same time, there is growing concern that a new "too big to fail" problem could arise, as the CCP industry is highly concentrated due to economies of scale. From a European perspective, it should be noted that the clearing of euro-denominated OTC derivatives mainly takes place in London, hence outside the EU in the foreseeable future. For some time there has been a controversial discussion as to whether this can remain the case post Brexit.
CCPs, which clear a significant proportion of euro OTC derivatives and are systemically relevant from an EU perspective, should be subject to direct supervision by EU authorities and should be established in the EU. This would represent an important building block for a future Capital Markets Union in Europe, as regulatory or supervisory arbitrage in favour of systemically important third- ountry CCPs could be prevented. In addition, if a systemically relevant CCP handling a considerable portion of the euro OTC derivatives business were to run into serious difficulties, this may impact ECB monetary policy. This applies both to demand for central bank money and to the transmission of monetary policy measures, which can be significantly impaired, particularly in the event that the repo market or payment systems are disrupted. It is therefore essential for the ECB to be closely involved in the supervision of CCPs. Against this background, the draft amendment of EMIR (European Market Infrastructure Regulation) presented on 13 June 2017 is a step in the right direction. In addition, there is an urgent need to introduce a recovery and resolution mechanism for CCPs in the EU to complement the existing single resolution mechanism (SRM) for banks in the eurozone. Only then can the diverse interdependencies between banks and CCPs be adequately taken into account in the recovery and resolution programmes required in a financial crisis.
The German government has recently adopted a reform package for the statutory pension insurance scheme to ensure that the pension level will not fall below 48% and that the contribution rate will not exceed 20% up to 2025. In addition, there are planned improvements in maternal pensions, pensions for people with reduced earnings capacity and relief for low-income earners. The total extra cost of these measures is estimated at approximately EUR 32bn, to be financed by funds of the statutory pension system and by increased federal subsidies. It is currently unclear how the German pay-as-you-go pension system will be reformed for the period after 2025. The author suggests establishing a “Pension Fund Germany” as a capital-backed fund with a highly diversified investment portfolio. A German sovereign wealth fund of this kind could make an important contribution to greater intergenerational equity. Financing could be provided by, for example, retaining part of the solidarity surcharge on German income tax rather than abolishing it entirely, as is currently envisaged.