Sustainable Architecture for Finance in Europe (SAFE)
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Using a structural life-cycle model, we quantify the heterogeneous impact of school closures during the Corona crisis on children affected at different ages and coming from households with different parental characteristics. In the model, public investment through schooling is combined with parental time and resource investments in the production of child human capital at different stages in the children’s development process. We quantitatively characterize the long-term consequences from a Covid-19 induced loss of schooling, and find average losses in the present discounted value of lifetime earnings of the affected children of close to 1%, as well as welfare losses equivalent to about 0.6% of permanent consumption. Due to self-productivity in the human capital production function, skill attainment at a younger stage of the life cycle raises skill attainment at later stages, and thus younger children are hurt more by the school closures than older children. We find that parental reactions reduce the negative impact of the school closures, but do not fully offset it. The negative impact of the crisis on children’s welfare is especially severe for those with parents with low educational attainment and low assets. The school closures themselves are primarily responsible for the negative impact of the Covid-19 shock on the long-run welfare of the children, with the pandemic-induced income shock to parents playing a secondary role.
We extend the canonical income process with persistent and transitory risk to cyclical shock distributions with left-skewness and excess kurtosis. We estimate our income process by GMM for US household data. We find countercyclical variance and procyclical skewness of persistent shocks. All shock distributions are highly leptokurtic. The tax and transfer system reduces dispersion and left-skewness. We then show that in a standard incomplete-markets life-cycle model, first, higherorder risk has sizable welfare implications, which depend on risk attitudes; second, it matters quantitatively for the welfare costs of cyclical idiosyncratic risk; third, it has non-trivial implications for self-insurance against shocks.
Historical evidence like the global financial crisis from 2007-09 highlights that sector concentration risk can play an important role for the solvency of insurers. However, current microprudential frameworks like the US RBC framework and Solvency II consider only name concentration risk explicitly in their solvency capital requirements for asset concentration risk and neglect sector concentration risk. We show by means of US insurers’ asset holdings from 2009 to 2018 that substantial sectoral asset concentrations exist in the financial, public and real estate sector, and find indicative evidence for a sectoral search for yield behavior. Based on a theoretical solvency capital allocation scheme, we demonstrate that the current regulatory approaches can lead to inappropriate and biased levels of solvency capital for asset concentration risk, and should be revised. Our findings have also important implications on the ongoing discussion of asset concentration risk in the context of macroprudential insurance regulation.
We consider an additively time-separable life-cycle model for the family of power period utility functions u such that u0(c) = c−θ for resistance to inter-temporal substitution of θ > 0. The utility maximization problem over life-time consumption is dynamically inconsistent for almost all specifications of effective discount factors. Pollak (1968) shows that the savings behavior of a sophisticated agent and her naive counterpart is always identical for a logarithmic utility function (i.e., for θ = 1). As an extension of Pollak’s result we show that the sophisticated agent saves a greater (smaller) fraction of her wealth in every period than her naive counterpart whenever θ > 1 (θ < 1) irrespective of the specification of discount factors. We further show that this finding extends to an environment with risky returns and dynamically inconsistent Epstein-Zin-Weil preferences.
Using a structural life-cycle model and data on school visits from Safegraph and school closures from Burbio, we quantify the heterogeneous impact of school closures during the Corona crisis on children affected at different ages and coming from households with different parental characteristics. Our data suggests that secondary schools were closed for in-person learning for longer periods than elementary schools (implying that younger children experienced less school closures than older children), and that private schools experienced shorter closures than public schools, and schools in poorer U.S. counties experienced shorter school closures. We then extend the structural life cycle model of private and public schooling investments studied in Fuchs-Schündeln, Krueger, Ludwig, and Popova (2021) to include the choice of parents whether to send their children to private schools, empirically discipline it with data on parental investments from the PSID, and then feed into the model the school closure measures from our empirical analysis to quantify the long-run consequences of the Covid-19 school closures on the cohorts of children currently in school. Future earnings- and welfare losses are largest for children that started public secondary schools at the onset of the Covid-19 crisis. Comparing children from the topto children from the bottom quartile of the income distribution, welfare losses are ca. 0.8 percentage points larger for the poorer children if school closures were unrelated to income. Accounting for the longer school closures in richer counties reduces this gap by about 1/3. A policy intervention that extends schools by 3 months (6 weeks in the next two summers) generates significant welfare gains for the children and raises future tax revenues approximately sufficient to pay for the cost of this schooling expansion.
Life insurance convexity
(2021)
Life insurers massively sell savings contracts with surrender options which allow policyholders to withdraw a guaranteed amount before maturity. These options move toward the money when interest rates rise. Using data on German life insurers, we estimate that a 1 percentage point increase in interest rates raises surrender rates by 17 basis points. We quantify the resulting liquidity risk in a calibrated model of surrender decisions and insurance cash flows. Simulations predict that surrender options can force insurers to sell up to 3% of their assets, depressing asset prices by 90 basis points. The effect is amplified by the duration of insurers' investments, and its impact on the term structure of interest rates depends on life insurers' investment strategy.
Tail-correlation matrices are an important tool for aggregating risk measurements across risk categories, asset classes and/or business segments. This paper demonstrates that traditional tail-correlation matrices—which are conventionally assumed to have ones on the diagonal—can lead to substantial biases of the aggregate risk measurement’s sensitivities with respect to risk exposures. Due to these biases, decision-makers receive an odd view of the effects of portfolio changes and may be unable to identify the optimal portfolio from a risk-return perspective. To overcome these issues, we introduce the “sensitivity-implied tail-correlation matrix”. The proposed tail-correlation matrix allows for a simple deterministic risk aggregation approach which reasonably approximates the true aggregate risk measurement according to the complete multivariate risk distribution. Numerical examples demonstrate that our approach is a better basis for portfolio optimization than the Value-at-Risk implied tail-correlation matrix, especially if the calibration portfolio (or current portfolio) deviates from the optimal portfolio.
I measure the effects of workers’ mobility across regions of different productivity through the lens of a search and matching model with heterogeneous workers and firms estimated with administrative data. In an application to Italy, I find that reallocation of workers to the most productive region boosts productivity at the country level but amplifies differentials across regions. Employment rates decline as migrants foster job competition, and inequality between workers doubles in less productive areas since displacement is particularly severe for low-skill workers. Migration does affect mismatch: mobility favors co-location of agents with similar productivity but within-region rank correlation declines in the most productive region. I show that worker-firm complementarities in production account for 33% of the productivity gains. Place-based programs directed to firms, like incentives for hiring unemployed or creating high productivity jobs, raise employment rates and reduce the gaps in productivity across regions. In contrast, subsidies to attract high-skill workers in the South have limited effects.
The meme stock phenomenon has yet to be explored. In this note, we provide evidence that these stocks display common stylized facts for the dynamics of price, trading volume, and social media activity. Using a regime-switching cointegration model, we identify the meme stock “mementum” which exhibits a different characterization compared to other stocks with high volumes of activity (persistent and not) on social media. Finally, we show that mementum is significant and positively related to the stock’s returns. Understanding these properties helps investors and market authorities in their decisions.
We study the role mutual funds play in the recovery from fast intraday crashes based on data from the National Stock Exchange of India for a single large stock. During normal times, trading activity and liquidity provision by mutual funds is negligible compared to other traders at around 4% of overall activity. Nevertheless, for the two intraday market-wide crashes in our sample, price recovery took place only after mutual funds moved in. Market stability may require the presence of well-capitalized standby liquidity providers for recovery from fast crashes.
Non-standard errors
(2021)
In statistics, samples are drawn from a population in a data-generating process (DGP). Standard errors measure the uncertainty in sample estimates of population parameters. In science, evidence is generated to test hypotheses in an evidence-generating process (EGP). We claim that EGP variation across researchers adds uncertainty: non-standard errors. To study them, we let 164 teams test six hypotheses on the same sample. We find that non-standard errors are sizeable, on par with standard errors. Their size (i) co-varies only weakly with team merits, reproducibility, or peer rating, (ii) declines significantly after peer-feedback, and (iii) is underestimated by participants.
Accounting for financial stability: Bank disclosure and loss recognition in the financial crisis
(2020)
This paper examines banks’ disclosures and loss recognition in the financial crisis and identifies several core issues for the link between accounting and financial stability. Our analysis suggests that, going into the financial crisis, banks’ disclosures about relevant risk exposures were relatively sparse. Such disclosures came later after major concerns about banks’ exposures had arisen in markets. Similarly, the recognition of loan losses was relatively slow and delayed relative to prevailing market expectations. Among the possible explanations for this evidence, our analysis suggests that banks’ reporting incentives played a key role, which has important implications for bank supervision and the new expected loss model for loan accounting. We also provide evidence that shielding regulatory capital from accounting losses through prudential filters can dampen banks’ incentives for corrective actions. Overall, our analysis reveals several important challenges if accounting and financial reporting are to contribute to financial stability.
The paper discusses the policy implications of the Wirecard scandal. The study finds that all lines of defense against corporate fraud, including internal control systems, external audits, the oversight bodies for financial reporting and auditing and the market supervisor, contributed to the scandal and are in need of reform. To ensure market integrity and investor protection in the future, the authors make eight suggestions for the market and institutional oversight architecture in Germany and in Europe.
We present evidence on the way personal and institutional factors could together guide public company directors in decision-making concerning shareholders and stakeholders. In a sample comprising more than nine hundred directors originating from over fifty countries and serving in firms from twenty three countries, we confirm that directors around the world hold a principled, quasi-ideological stance towards shareholders and stakeholders, called shareholderism, on which they vary in line with their personal values. We theorize and find that in addition to personal values, directors’ shareholderism level associates with cultural norms that are conducive to entrepreneurship. Among legal factors, only creditor protection exhibits a negative correlation with shareholderism, while general legal origin and proxies for shareholder and employee protection are unrelated to it.
Did the Federal Reserves’ Quantitative Easing (QE) in the aftermath of the financial crisis have macroeconomic effects? To answer this question, the authors estimate a large-scale DSGE model over the sample from 1998 to 2020, including data of the Fed’s balance sheet. The authors allow for QE to affect the economy via multiple channels that arise from several financial frictions. Their nonlinear Bayesian likelihood approach fully accounts for the zero lower bound on nominal interest rates. They find that between 2009 to 2015, QE increased output by about 1.2 percent. This reflects a net increase in investment of nearly 9 percent, that was accompanied by a 0.7 percent drop in aggregate consumption. Both, government bond and capital asset purchases were effective in improving financing conditions. Especially capital asset purchases significantly facilitated new investment and increased the production capacity. Against the backdrop of a fall in consumption, supply side effects dominated which led to a mild disinflationary effect of about 0.25 percent annually.
Using a nonlinear Bayesian likelihood approach that fully accounts for the zero lower bound on nominal interest rates, the authors analyze US post-crisis business cycle dynamics and provide reference parameter estimates. They find that neither the inclusion of financial frictions nor that of household heterogeneity improve the empirical fit of the standard model, or its ability to provide a joint explanation for the post-2007 dynamics. Associated financial shocks mis-predict an increase in consumption. The common practice of omitting the ZLB period in the estimation severely distorts the analysis of the more recent economic dynamics.
An important question in banking is how strict supervision affects bank lending and in turn local business activity. Supervisors forcing banks to recognize losses could choke off lending and amplify local economic woes. But stricter supervision could also change how banks assess and manage loans. Estimating such effects is challenging. We exploit the extinction of the thrift regulator (OTS) to analyze economic links between strict supervision, bank lending and business activity. We first show that the OTS replacement indeed resulted in stricter supervision of former OTS banks. Next, we analyze the ensuing lending effects. We show that former OTS banks increase small business lending by roughly 10 percent. This increase is concentrated in well-capitalized banks, those more affected by the new regime, and cannot be fully explained by a reallocation from mortgage to small business lending after the crisis. These findings suggest that stricter supervision operates not only through capital but can also correct deficiencies in bank management and lending practices, leading to more lending and a reallocation of loans.
This paper documents that resource reallocation across firms is an important mechanism through which creditor rights affect real outcomes. I exploit the staggered adoption of an international convention that provides globally consistent strong creditor protection for aircraft finance. After this reform, country-level productivity in the aviation sector increases by 12%, driven mostly by across-firm reallocation. Productive airlines borrow more, expand, and adopt new technology at the expense of unproductive ones. Such reallocation is facilitated by (i) easier and quicker asset redeployment; and (ii) the influx of foreign financiers offering innovative financial products to improve credit allocative efficiency. I further document an increase in competition and an improvement in the breadth and the quality of products available to consumers.