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We focus on the role of social media as a high-frequency, unfiltered mass information transmission channel and how its use for government communication affects the aggregate stock markets. To measure this effect, we concentrate on one of the most prominent Twitter users, the 45th President of the United States, Donald J. Trump. We analyze around 1,400 of his tweets related to the US economy and classify them by topic and textual sentiment using machine learning algorithms. We investigate whether the tweets contain relevant information for financial markets, i.e. whether they affect market returns, volatility, and trading volumes. Using high-frequency data, we find that Trump’s tweets are most often a reaction to pre-existing market trends and therefore do not provide material new information that would influence prices or trading. We show that past market information can help predict Trump’s decision to tweet about the economy.
Using loan-level data from Germany, we investigate how the introduction of model-based capital regulation affected banks’ ability to absorb shocks. The objective of this regulation was to enhance financial stability by making capital requirements responsive to asset risk. Our evidence suggests that banks ‘optimized’ model-based regulation to lower their capital requirements. Banks systematically underreported risk, with under reporting being more pronounced for banks with higher gains from it. Moreover, large banks benefitted from the regulation at the expense of smaller banks. Overall, our results suggest that sophisticated rules may have undesired effects if strategic misbehavior is difficult to detect.
SAFE Update June 2021
(2021)
This paper aims at an improved understanding of the relationship between monetary policy and racial inequality. We investigate the distributional effects of monetary policy in a unified framework, linking monetary policy shocks both to earnings and wealth differentials between black and white households. Specifically, we show that, although a more accommodative monetary policy increases employment of black households more than white households, the overall effects are small. At the same time, an accommodative monetary policy shock exacerbates the wealth difference between black and white households, because black households own less financial assets that appreciate in value. Over multi-year time horizons, the employment effects are substantially smaller than the countervailing portfolio effects. We conclude that there is little reason to think that accommodative monetary policy plays a significant role in reducing racial inequities in the way often discussed. On the contrary, it may well accentuate inequalities for extended periods.
The FOMC risk shift
(2021)
We identify a component of monetary policy news that is extracted from high-frequency changes in risky asset prices. These surprises, which we call “risk shifts”, are uncorrelated, and therefore complementary, to risk-free rate surprises. We show that (i) risk shifts capture the lion’s share of stock price movements around FOMC announcements; (ii) that they are accompanied by significant investor fund flows, suggesting that investors react heterogeneously to monetary policy news; and (iii) that price pressure amplifies the stock market response to monetary policy news. Our results imply that central bank information effects are overshadowed by short-term dynamics stemming from investor rebalancing activities and are likely to be more difficult to identify than previously thought.
Although the elderly are more vulnerable to COVID-19, the empirical evidence suggests that they do not behave more cautiously in the pandemic than younger individuals. This theoretical model argues that some individuals might not comply with the COVID-19 measures to reassure themselves that they are not vulnerable, and that the incentives for such self-signaling can be stronger for the elderly. The results suggest that communication strategies emphasizing the dangers of COVID-19 could backfire and reduce compliance among the elderly.
How people form beliefs is crucial for understanding decision-making un- der uncertainty. This is particularly true in a situation such as a pandemic, where beliefs will affect behaviors that impact public health as well as the aggregate economy. We conduct two survey experiments to shed light on potential biases in belief formation, focusing in particular on the tone of information people choose to consume and how they incorporate this information into their beliefs. In the first experiment, people express their preferences over pandemic-related articles with optimistic and pessimistic headlines, and are then randomly shown one of the articles. We find that respondents with more pessimistic prior beliefs about the pandemic are substantially more likely to prefer pessimistic articles, which we interpret as evidence of confirmation bias. In line with this, respondents assigned to the less preferred article rate it as less reliable and informative (relative to those who prefer it); they also discount information from the article when it is less preferred. We further find that these motivated beliefs end up impacting incentivized behavior. In a second experiment, we study how partisan views interact with information selection and processing. We find strong evidence of source dependence: revealing the news source further distorts information acquisition and processing, eliminating the role of prior beliefs in article choice.
We raise some critical points against a naïve interpretation of “green finance” products and strategies. These critical insights are the background against which we take a closer look at instruments and policies that might allow green finance to become more impactful. In particular, we focus on the role of a taxonomy and investor activism. We also describe the interaction of government policies with green finance practice – an aspect, which has been mostly neglected in policy debates but needs to be taken into account. Finally, the special case of green government bonds is discussed.
The authors embed human capital-based endogenous growth into a New-Keynesian model with search and matching frictions in the labor market and skill obsolescence from long-term unemployment. The model can account for key features of the Great Recession: a decline in productivity growth, the relative stability of inflation despite a pronounced fall in output (the "missing disinflation puzzle"), and a permanent gap between output and the pre-crisis trend output.
In the model, lower aggregate demand raises unemployment and the training costs associated with skill obsolescence. Lower employment hinders learning-by-doing, which slows down human capital accumulation, feeding back into even fewer vacancies than justified by the demand shock alone. These feedback channels mitigate the disinflationary effect of the demand shock while amplifying its contractionary effect on output. The temporary growth slowdown translates into output hysteresis (permanently lower output and labor productivity).
Central banks sometimes evaluate their own policies. To assess the inherent conflict of interest, the authors compare the research findings of central bank researchers and academic economists regarding the macroeconomic effects of quantitative easing (QE). They find that central bank papers report larger effects of QE on output and inflation. Central bankers are also more likely to report significant effects of QE on output and to use more positive language in the abstract. Central bankers who report larger QE effects on output experience more favorable career outcomes. A survey of central banks reveals substantial involvement of bank management in research production.
Despite the increasing use of cashless payment instruments, the notion that cash loses importance over time can be unambiguously refuted. In contrast, the authors show that cash demand increased steeply over the past 30 years. This is not only true on a global scale, but also for the most important currencies in advanced countries (USD, EUR, CHF, GBP and JPY). In this paper, they focus especially on the role of different crises (technological crises, financial market crises, natural disasters) and analyse the demand for small and large banknote denominations since the 1990s in an international perspective. It is evident that cash demand always increases in times of crises, independent of the nature of the crisis itself. However, largely unaffected from crises we observe a trend increase in global cash aligned with a shift from transaction balances towards more hoarding, especially in the form of large denomination banknotes.
Occasionally binding constraints have become an important part of economic modelling, especially since western central banks see themselves (again) constraint by the so-called zero lower bound (ZLB) of the nominal interest rate. A binding ZLB constraint poses a major problem for a quantitative-structural analysis: Linear solution methods do no work in the presence of a non-linearity such as the ZLB and existing alternatives tend to be computationally demanding. The urge to study macroeconomic questions related to the Great Recession and the Covid-19 crisis in a quantitative-structural framework requires algorithms that are not only accurate, but that are also robust, fast, and computationally efficient.
A particularly important application where efficient and fast methods for occasionally binding constraints (OBCs) are needed is the Bayesian estimation of macroeconomic models. This paper shows that a linear dynamic rational expectations system with OBCs, depending on the expected duration of the constraint, can be represented in closed form. Combined with a set of simple equilibrium conditions, this can be exploited to avoid matrix inversions and simulations at runtime for signifcant gains in computational speed.
High-frequency changes in interest rates around FOMC announcements are a standard method of measuring monetary policy shocks. However, some recent studies have documented puzzling effects of these shocks on private-sector forecasts of GDP, unemployment, or inflation that are opposite in sign to what standard macroeconomic models would predict. This evidence has been viewed as supportive of a „Fed information effect“ channel of monetary policy, whereby an FOMC tightening (easing) communicates that the economy is stronger (weaker) than the public had expected.
The authors show that these empirical results are also consistent with a „Fed response to news“ channel, in which incoming, publicly available economic news causes both the Fed to change monetary policy and the private sector to revise its forecasts. They provide substantial new evidence that distinguishes between these two channels and strongly favors the latter; for example, regressions that include the previously omitted public macroeconomic news, high-frequency stock market responses to Fed announcements, and a new survey that they conduct of individual Blue Chip forecasters all indicate that the Fed and private sector are simply responding to the same public news, and that there is little if any role for a „Fed information effect“.
The authors examine the effectiveness of labor cost reductions as a means to stimulate economic activity and assesses the differences which may occur with the prevailing exchange rate regime. They develop a medium-scale three-region DSGE model and show that the impact of a cut in the employers’ social security contributions rate does not vary significantly under different exchange rate regimes. They find that both the interest rate and the exchange rate channel matters. Furthermore, the measure appears to be effective even if it comes along with a consumption tax increase to preserve long-term fiscal sustainability.
Finally, they assess whether obtained theoretical results hold up empirically by applying the local projection method. Regression results suggest that changes in employers’ social security contributions rates have statistically significant real effects – a one percentage point reduction leads to an average cumulative rise in output of around 1.3 percent in the medium term. Moreover, the outcome does not differ significantly across the different exchange rate regimes.
The recently observed disconnect between inflation and economic activity can be explained by the interplay between the zero lower bound (ZLB) and the costs of external financing. In normal times, credit spreads and the nominal interest rate balance out; factor costs dominate firms' marginal costs. When nominal rates are constrained, larger spreads can more than offset the effect of lower factor costs and induce only moderate inflation responses. The Phillips curve is hence flat at the ZLB, but features a positive slope in normal times and thus a hockey stick shape. Via this mechanism, forward guidance may induce deflationary effects.
Can boundedly rational agents survive competition with fully rational agents? The authors develop a highly nonlinear heterogeneous agents model with rational forward looking versus boundedly rational backward looking agents and evolving market shares depending on their relative performance. Their novel numerical solution method detects equilibrium paths characterized by complex bubble and crash dynamics. Boundedly rational trend-extrapolators amplify small deviations from fundamentals, while rational agents anticipate market crashes after large bubbles and drive prices back close to fundamental value. Overall rational and non-rational beliefs co-evolve over time, with time-varying impact, and their interaction produces complex endogenous bubble and crashes, without any exogenous shocks.
On the accuracy of linear DSGE solution methods and the consequences for log-normal asset pricing
(2021)
This paper demonstrates a failure of standard, generalized Schur (or QZ) decomposition based solutions methods for linear dynamic stochastic general equilibrium (DSGE) models when there is insufficient eigenvalue separation about the unit circle. The significance of this is demonstrated in a simple production-based asset pricing model with external habit formation. While the exact solution afforded by the simplicity of the model matches post-war US consumption growth and the equity premium, QZ-based numerical solutions miss the later by many annualized percentage points.
The crisis management and deposit insurance (CMDI) framework in the euro area requires a reset. Although its policy objectives remain valid, the means of achieving them do not. As the euro area comes the end of the long transition period taken to implement the BRRD/SRMR, it should take the opportunity to reset expectations about resolution.
Above all, resolution should be for the many, not just the few. There should be a single presumptive path for dealing with failed banks: the use of bail-in to facilitate orderly liquidation under a solvent-wind down strategy. This will protect deposits and set the stage – together with the backstop that the European Stability Mechanism provides to the Single Resolution Fund (SRF) -- for the transformation of the SRF into the Single Deposit Guarantee Scheme (SDGS). To avoid forbearance, responsibility for emergency liquidity assistance (ELA) should rest, not with national central banks, but with the ECB as a single lender of last resort. Finally, national deposit guarantee schemes should function as institutional protection schemes and become investors of last resort in their member banks. Together, these measures would complete Banking Union, promote market discipline, avoid imposing additional burdens on taxpayers, help untie the doom loop between weak banks and weak governments, strengthen the euro and enhance financial stability.
This in-depth analysis provides evidence on differences in the practice of supervising large banks in the UK and in the euro area. It identifies the diverging institutional architecture (partially supranationalised vs. national oversight) as a pivotal determinant for a higher effectiveness of supervisory decision making in the UK. The ECB is likely to take a more stringent stance in prudential supervision than UK authorities. The setting of risk weights and the design of macroprudential stress test scenarios document this hypothesis. This document was provided by the Economic Governance Support Unit at the request of the ECON Committee.
This document was requested by the European Parliament's Committee on Economic and Monetary Affairs. It was originally published on the European Parliament’s webpage: www.europarl.europa.eu/RegData/etudes/IDAN/2021/689443/IPOL_IDA(2021)689443_EN.pdf
This in-depth analysis proposes ways to retract from supervisory COVID-19 support measures without perils for financial stability. It simulates the likely impact of the corona crisis on euro area banks’ capital and predicts a significant capital shortfall. We recommend to end accounting practices that conceal loan losses and sustain capital relief measures. Our in-depth analysis also proposes how to address the impending capital shortfall in resolution/liquidation and a supranational recapitalisation.
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.
Central banks normally accept debt of their own governments as collateral in liquidity operations without reservations. This gives rise to a valuable liquidity premium that reduces the cost of government finance. The ECB is an interesting exception in this respect. It relies on external assessments of the creditworthiness of its member states, such as credit ratings, to determine eligibility and the haircut it imposes on such debt. The authors show how such features in a central bank’s collateral framework can give rise to cliff effects and multiple equilibria in bond yields and increase the vulnerability of governments to external shocks. This can potentially induce sovereign debt crises and defaults that would not otherwise arise.
We raise some critical points against a naïve interpretation of “green finance” products and strategies. These critical insights are the background against which we take a closer look at instruments and policies that might allow green finance to become more impactful. In particular, we focus on the role of a taxonomy and investor activism. We also describe the interaction of government policies with green finance practice – an aspect, which has been mostly neglected in policy debates but needs to be taken into account. Finally, the special case of green government bonds is discussed.
We show that financial advisors recommend more costly products to female clients, based on minutes from about 27,000 real-world advisory meetings and client portfolio data. Funds recommended to women have higher expense ratios controlling for risk, and women less often receive rebates on upfront fees for any given fund. We develop a model relating these findings to client stereotyping, and empirically verify an additional prediction: Women (but not men) with higher financial aptitude reject recommendations more frequently. Women state a preference for delegating financial decisions, but appear unaware of associated higher costs. Evidence of stereotyping is stronger for male advisors.
The pricing of an ambiguous asset, whose cash flow stream is uncertain, may be affected by three factors: the belief regarding the realization likelihood of cash flows, the subjective attitude towards risk, and the attitude towards ambiguity. While previous literature looks at the total price discount under ambiguity, this paper investigates with laboratory experiments how much effect each factor can induce. We apply both non-parametric and parametric methods to cleanly separate the belief effects, the risk premiums, and the ambiguity premiums from each other. Both methods lead to similar results: Overall, subjects have substantial ambiguity aversion, and ambiguity premiums account for the largest price deviation component when the degree of ambiguity is high. As information accumulates, ambiguity premiums decrease. We also find that beliefs do influence prices under ambiguity. This is not because beliefs are biased towards either good or bad scenarios per se, but because subjects display sticky belief updating as new information becomes available. The clear separation performed in this paper between belief and attitude also enables a more accurate estimation of the parameter of ambiguity aversion compared to previous studies, since the effect of beliefs is partialled out. Overall, we find empirically that both factors, belief and attitude towards ambiguity, are important factors in pricing under ambiguity.
The salience of ESG ratings for stock pricing: evidence from (potentially) confused investors
(2021)
We exploit the a modification to Sustainanlytics’ environmental, social, and governance (ESG) rating methodology, which is subsequently adopted by Morningstar, to study whether ESG ratings are salient for stock pricing. We show that the inversion of the rating scale but not new information leads some investors to make incorrect assessments about the meaning of the change in ESG ratings. They buy (sell) stocks they misconceive as ESG upgraded (downgraded) even when the opposite is true. This trading behavior exerts transitory price pressure on affected stocks. Our paper highlights the importance of ESG ratings for investors and consequently for asset prices.
We conducted a large-scale household survey in November 2020 to study how altering the time frame of a message (temporal framing) regarding an imminent positive income shock affects consumption plans. The income shock derives from the abolishment of the German solidarity surcharge on personal income taxes, effective in January 2021. We randomize across survey participants whether their extra disposable income is presented in Euros per month, Euros per year, or Euros per ten year-period. Our main findings are as follows: In General, we find our respondents’ intended Marginal Propensity to Consume (MPC) is 28.2%. Across all three treatments, the MPC is a positive function of age and being female while it is a negative function of the income increase’s size, self- control, and being unemployed. Temporal framing effects are statistically and economically highly significant as we find the monthly treatment groups’ average MPC 5.6 and 8.7 percentage points higher compared to the yearly and 10-yearly treatment groups. We will be able to analyze the real consumption behavior of households throughout 2021 based on re-surveying the participants as well as by using transaction-based bank data.
Nach der Bundestagswahl am 26. September 2021 wird sich die künftige Bundesregierung mit einer Reihe drängender Herausforderungen befassen müssen. Aus Sicht des Leibniz-Instituts für Finanzmarktforschung SAFE haben die folgenden, miteinander verbundenen Einzelpunkte dabei Priorität:
1. Schaffung eines ordnungspolitischen Pakets zur Sicherung globaler Gemeinschaftsgüter, wie etwa des Klimas
2. Initiative zum Aufbau notwendiger Datensätze und Standards für eine zielgenaue Nachhaltigkeitsgestaltung an den Finanzmärkten
3. regulatorischer Fahrplan zur Erfassung, Ermöglichung und Einhegung einer digitalen Transformation des Finanzsystems
4. Vollendung der Bankenunion, insbesondere durch einen „europäischen Schlussstein“: der Schaffung einer einheitlichen Aufsicht und Letztabsicherung
5. Durchbrechung des „Doom-Loop“ zwischen Staaten und Banken in Europa, insbesondere durch Begrenzung des Umfangs, in dem eigene Staatsanleihen im Portfolio von Banken liegen dürfen
6. ernsthafter Versuch zur Schaffung eines einheitlichen und integren europäischen Kapitalmarkts mit einer Aufsicht nach US-Vorbild
7. Banken- und Kapitalmarktunion als wesentliche Bausteine für eine grundlegende Reform der Altersversorgung mit mehr Teilhabe aller Bürger:innen an der Leistungsentwicklung der Volkswirtschaft
This policy white paper shows, using data on European Commission (EC) lobby meetings, that financial institutions and finance trade associations have substantial access to EC policymakers. While lobbying could transfer policy-relevant information and expertise to policymakers, it could also result in the capture of policymakers by the industry, which could harm consumers and taxpayers. How could policymakers prevent regulatory capture, but retain the benefits of the sector expertise in policy decisions? Awareness of regulatory capture by policymakers is one of the most important remedies. This paper provides an overview of the origins of the regulatory capture theory and recent academic evidence. The paper shows that regulatory capture could emerge in a variety of institutions and policy areas but is not ubiquitous and depends on the incentives of policymakers and the policy environment. Subsequently, the paper discusses various measures to prevent regulatory capture, such as more transparency, diverse expert groups, and cooling-off periods.
With the second wave of the Covid-19 pandemic in full swing, banks face a challenging environment. They will need to address disappointing results and adverse balance sheet restatements, the intensity of which depends on the evolution of the euro area economies. At the same time, vulnerable banks reinforce real economy deficiencies. The contribution of this paper is to provide a comparative assessment of the various policy responses to address a looming banking crisis. Such a crisis will fully materialize when non-performing assets drag down banks simultaneously, raising the specter of a full-blown systemic crisis. The policy responses available range from forbearance, recapitalization (with public or private resources), asset separation (bad banks, at national or EU level), to debt conversion schemes. We evaluate these responses according to a set of five criteria that define the efficacy of each. These responses are not mutually exclusive, in practice, as they have never been. They may also go hand in hand with other restructuring initiatives, including potential consolidation in the banking sector. Although we do not make a specific recommendation, we provide a framework for policymakers to guide them in their decision making.
We study risk taking in a panel of subjects in Wuhan, China - before, during the COVID-19 crisis, and after the country reopened. Subjects in our sample traveled for semester break in January, generating variation in exposure to the virus and quarantine in Wuhan. Higher exposure leads subjects to reduce planned risk taking, risky investments, and optimism. Our findings help unify existing studies by showing that aggregate shocks affect general preferences for risk and economic expectations, while heterogeneity in experience further affect risk taking through beliefs about individuals’ own outcomes such as luck and sense of control.
JEL Classification: G50, G51, G11, D14, G41
In this paper we put forward a legal argument in favour of granting more independence to BaFin, the German securities market supervisor. Following the Wirecard scandal, our reform proposal aims at strengthening the impartiality and credibility of the German supervisor and, as a consequence, at restoring capital market integrity. In order to achieve the necessary degree of democratic legitimacy for giving BaFin more independence and disassociating it from the Ministry of Finance, the paper sets out the necessary steps for a legal reform that creates accountability of BaFin vis-à-vis the Parliament, subjecting it to strict disclosure and reporting obligations.
Managed portfolios that exploit positive first-order autocorrelation in monthly excess returns of equity factor portfolios produce large alphas and gains in Sharpe ratios. We document this finding for factor portfolios formed on the broad market, size, value, momentum, investment, prof- itability, and volatility. The value-added induced by factor management via short-term momentum is a robust empirical phenomenon that survives transaction costs and carries over to multi-factor portfolios. The novel strategy established in this work compares favorably to well-known timing strategies that employ e.g. factor volatility or factor valuation. For the majority of factors, our strategies appear successful especially in recessions and times of crisis.
Climate change is one of the highest-ranking issues on the political and social agenda. Vulnerabilities of the world ecosystem laid bare by the COVID-19 pandemic and the potential damage for the human and business life made the need for urgent action clear once again. Corporations are one of the main actors that will play a major role in the decarbonisation of the economy. They need to put forward a net zero strategy and targets, transitioning to net-zero by 2050. Yet, an important but rather overlooked stakeholder group in the sustainability debates can pose a significant stumbling block in this transition: employees. Although climate action has huge benefits by ameliorating adverse environmental events and is expected to have overall positive impact on employment, net zero transition in companies, especially in certain sectors and regions, will cause substantial adverse employment effects for the workforce. This has the potential to slow down or even derail the necessary climate action in companies. In this regard, just transition is a promising concept, which calls for a swift and decisive climate action in corporations while taking account of and mitigating adverse effects for their workforce. If well implemented, it can accelerate net zero transition in companies. This potential clash of environmental (E) and social (S) aspects of ESG agenda, materialised in the companies’ net zero transition, and its potential remedy, just transition, have important implications for corporate governance and finance, especially for directors’ duties & executive remuneration, sustainability disclosures, institutional investors’ engagement and green finance.
This paper examines how the transmission of government portfolio risk arising from maturity operations depends on the stance of monetary/fiscal policy. Accounting for risk premia in the fiscal theory allows the government portfolio to affect the expected inflation, even in a frictionless economy. The effects of maturity rebalancing on expected inflation in the fiscal theory directly depend on the conditional nominal term premium, giving rise to an optimal debt maturity policy that is state dependent. In a calibrated macro-finance model, we demonstrate that maturity operations have sizable effects on expected inflation and output through our novel risk transmission mechanism.
This paper sets up an experimental asset market in the laboratory to investigate the effects of ambiguity on price formation and trading behavior in financial markets. The obtained trading data is used to analyze the effect of ambiguity on various market outcomes (the price level, volatility, trading activity, market liquidity, and the degree of speculative trading) and to test the quality of popular empirical market-based measures for the degree of ambiguity. We find that ambiguity decreases market prices and trading activity; ambiguity leads to lower market liquidity through wider bid-ask spreads; and ambiguity leads to less speculative trading. We also find that popular market-based measures of ambiguity used in the empirical literature do not seem to correctly capture the true degree of ambiguity.
Analysing causality among oil prices and, in general, among financial and economic variables is of central relevance in applied economics studies. The recent contribution of Lu et al. (2014) proposes a novel test for causality— the DCC-MGARCH Hong test. We show that the critical values of the test statistic must be evaluated through simulations, thereby challenging the evidence in papers adopting the DCC-MGARCH Hong test. We also note that rolling Hong tests represent a more viable solution in the presence of short-lived causality periods.
We show that the COVID-19 pandemic triggered a surge in the elasticity of non-financial corporate to sovereign credit default swaps in core EU countries, characterized by strong fiscal capacity. For peripheral countries with lower budgetary slackness, the pandemic had essentially no impact on such elasticity. This evidence is consistent with the disaster-induced repricing of government support, which we model through a rare-disaster asset pricing framework with bailout guarantees and defaultable public debt. The model implies that risk-adjusted guarantees in the core were 2.6 times those in the periphery, suggesting that fiscal capacity buffers provide relief to firms’ financing costs.
This paper studies the consumption response to an increase in the domestic value of foreign currency household debt during a large depreciation. We use detailed consumption survey data that follows households for four years around Hungary’s 2008 currency crisis. We find that, relative to similar local currency debtors, foreign currency debtors reduce consumption approximately one-for-one with increased debt service, suggesting a role for liquidity constraints. We document a variety of margins of adjustment to the shock. Foreign currency debtors reduce both the quantity and quality of expenditures, consistent with nonhomothetic preferences and “flight from quality.” We find no effect on overall household labor supply, consistent with a weak wealth effect on labor supply. However, a small subset of households adjusts labor supply toward foreign income streams. Affected households also boost home pro- duction, suggesting a shift in consumption from money-intensive to time-intensive goods.
We analyze the impact of decreases in available lending resources on quantitative and qualita- tive dimensions of firms’ patenting activities. We thereby make use of the European Banking Authority?s capital exercise to carve out the causal effect of bank lending on firm innovation. In order to do so we combine various datasets to derive information on firms’ financials, their patenting behaviors, as well as their relationships with their lenders. Building on this self- generated dataset, we provide support for the “less finance, less innovation” view. At the same time, we show that lower available financial resources for firms lead to improvement in the qualitative dimensions of their patents. Hence, we carve out a “less finance, less but better innovation” pattern.
We define a sentiment indicator that exploits two contrasting views of return predictability, and study its properties. The indicator, which is based on option prices, valuation ratios and interest rates, was unusually high during the late 1990s, reflecting dividend growth expectations that in our view were unreasonably optimistic. We interpret it as helping to reveal irrational beliefs about fundamentals. We show that our measure is a leading indicator of detrended volume, and of various other measures associated with financial fragility. We also make two methodological contributions. First, we derive a new valuation-ratio decomposition that is related to the Campbell and Shiller (1988) loglinearization, but which resembles the traditional Gordon growth model more closely and has certain other advantages for our purposes. Second, we introduce a volatility index that provides a lower bound on the market's expected log return.
This paper explores the interplay of feature-based explainable AI (XAI) tech- niques, information processing, and human beliefs. Using a novel experimental protocol, we study the impact of providing users with explanations about how an AI system weighs inputted information to produce individual predictions (LIME) on users’ weighting of information and beliefs about the task-relevance of information. On the one hand, we find that feature-based explanations cause users to alter their mental weighting of available information according to observed explanations. On the other hand, explanations lead to asymmetric belief adjustments that we inter- pret as a manifestation of the confirmation bias. Trust in the prediction accuracy plays an important moderating role for XAI-enabled belief adjustments. Our results show that feature-based XAI does not only superficially influence decisions but re- ally change internal cognitive processes, bearing the potential to manipulate human beliefs and reinforce stereotypes. Hence, the current regulatory efforts that aim at enhancing algorithmic transparency may benefit from going hand in hand with measures ensuring the exclusion of sensitive personal information in XAI systems. Overall, our findings put assertions that XAI is the silver bullet solving all of AI systems’ (black box) problems into perspective.
Many equity markets combine continuous trading and call auctions. Oftentimes designated market makers (DMMs) supply additional liquidity. Whereas prior research has focused on their role in continuous trading, we provide a detailed analysis of their activity in call auctions. Using data from Germany’s Xetra system, we find that DMMs are most active when they can provide the greatest benefits to the market, i.e., in relatively illiquid stocks and at times of elevated volatility. Their trades stabilize prices and they trade profitably.
Incentives, self-selection, and coordination of motivated agents for the production of social goods
(2021)
We study, theoretically and empirically, the effects of incentives on the self-selection and coordination of motivated agents to produce a social good. Agents join teams where they allocate effort to either generate individual monetary rewards (selfish effort) or contribute to the production of a social good with positive effort complementarities (social effort). Agents differ in their motivation to exert social effort. Our model predicts that lowering incentives for selfish effort in one team increases social good production by selectively attracting and coordinating motivated agents. We test this prediction in a lab experiment allowing us to cleanly separate the selection effect from other effects of low incentives. Results show that social good production more than doubles in the low- incentive team, but only if self-selection is possible. Our analysis highlights the important role of incentives in the matching of motivated agents engaged in social good production.
We investigate the differential effect of the COVID-19 shock to the stock market shock on the share prices of firms with different levels of ESG (Environmental, Social and Governance) scores. Thereby, we analyse whether and to what extent better ESG ratings provided insurance for investors in the stocks of those firms during this shock. We focus our analysis on the European market in which ESG investment plays a particularly important role. Using a broad sample of listed firms we provide mixed evidence. On the one hand, we show that immediately after the start of the shock firms with a higher ESG score outperformed their peers. On the other hand, this effect faded less than six weeks later. Given the quick recovery of the market our finding supports the idea that ESG stocks provide limited insurance in severe crises.
Market risks account for an integral part of life insurers' risk profiles. This paper explores the market risk sensitivities of insurers in two large life insurance markets, namely the U.S. and Europe. Based on panel regression models and daily market data from 2012 to 2018, we analyze the reaction of insurers' stock returns to changes in interest rates and CDS spreads of sovereign counterparties. We find that the influence of interest rate movements on stock returns is more than 50% larger for U.S. than for European life insurers. Falling interest rates reduce stock returns in particular for less solvent firms, insurers with a high share of life insurance reserves and unit-linked insurers. Moreover, life insurers' sensitivity to interest rate changes is seven times larger than their sensitivity towards CDS spreads. Only European insurers significantly suffer from rising CDS spreads, whereas U.S. insurers are immunized against increasing sovereign default probabilities.
We characterize the optimal linear tax on capital in an Overlapping Generations model with two period lived households facing uninsurable idiosyncratic labor income risk. The Ramsey government internalizes the general equilibrium effects of private precautionary saving on factor prices and taxes capital unless the weight on future generations in the social welfare function is sufficiently high. For logarithmic utility a complete analytical solution of the Ramsey problem exhibits an optimal aggregate saving rate that is independent of income risk, whereas the optimal time-invariant tax on capital implementing this saving rate is increasing in income risk. The optimal saving rate is constant along the transition and its sign depends on the magnitude of risk and on the Pareto weight of future generations. If the Ramsey tax rate that maximizes steady state utility is positive, then implementing this tax rate permanently induces a Pareto-improving transition even if the initial equilibrium capital stock is below the golden rule.
This paper documents that the bond investments of insurance companies transmit shocks from insurance markets to the real economy. Liquidity windfalls from household insurance purchases increase insurers’ demand for corporate bonds. Exploiting the fact that insurers persistently invest in a small subset of firms for identification, I show that these increases in bond demand raise bond prices and lower firms’ funding costs. In response, firms issue more bonds, especially when their bond underwriters are well connected with investors. Firms use the proceeds to raise investment rather than equity payouts. The results emphasize the significant impact of investor demand on firms’ financing and investment activities.