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Between 2016 and 2022, life insurers in several European countries experienced negative longterm interest rates, which put pressure on their business models. The aim of this paper is to empirically investigate the impact of negative interest rates on the stock performance of life insurers. To measure the sensitivities, I estimate the level, slope, and curvature of the yield curve using the Nelson-Siegel model and empirical proxies. Panel regressions show that the effect of changes in the level is up to three times greater in a negative interest rate environment than in a positive one. Thus, a 1ppt decline in long-term interest rates reduces the stock returns of European life insurers by up to 10ppt when interest rates are below 0%. I also show that the relationship between the level and the sensitivity to interest rates is convex, and that life insurers benefit from rising interest rates across all maturity types.
Homeownership rates differ widely across European countries. We document that part of this variation is driven by differences in the fraction of adults co-residing with their parents. Comparing Germany and Italy, we show that in contrast to homeownership rates per household, homeownership rates per individual are very similar during the first part of the life cycle. To understand these patterns, we build an overlapping-generations model where individuals face uninsurable income risk and make consumption-saving and housing tenure decisions. We embed an explicit intergenerational link between children and parents to capture the three-way trade-off between owning, renting, and co-residing. Calibrating the model to Germany we explore the role of income profiles, housing policies, and the taste for independence and show that a combination of these factors goes a long way in explaining the differential life-cycle patterns of living arrangements between the two countries.
In crisis times, insurance companies might feel the pressure to present an investment portfolio performance that is superior to the market, since investment portfolios back the claims of policyholders and serve as a signal for the claims’ safety. I investigate how a stock market crisis as experienced over the course of the Covid-19 pandemic influences insurance firms’ decisions on the allocation of their corporate bond portfolio. I find that insurers shift their portfolio holdings towards lower credit risk assets as financial market conditions tighten. This tendency seems to be restricted by the liquidity risk of high-yield assets, and the credit risk of lower-rated investment grade assets. Both effects lead to an increase in the fraction of less liquid assets during the crash and the recovery.
The capital requirements of Solvency II allow insurers to make discretionary choices. Besides extensive possibilities regarding the choice of a risk model (ranging between a regulatory prescribed standard formula to a full self-developed internal model), insurers can make use of transitional measures and adjustments, which can have a substantial impact on their reported solvency level. The aim of this article is to study the effect of these long-term guarantee measures and to identify drivers of the discretionary decisions. For this purpose, we first assess the risk profile of 49 European insurers by estimating the sensitivities of their stock returns to movements in market risk drivers, such as interest rates and credit spreads. In a second step, we analyze to what extent insurers’ risk profiles influence their discretionary decisions in the capital requirement calculation. We gather information on discretionary decisions based on hand-collected Solvency II data for the years 2016 to 2020. We find that insurers optimize their reported solvency situation by making discretionary decisions in such a way that capital requirements for material risk drivers are clearly reduced. For instance, we find that the usage of the volatility adjustment is positively related to the interest rate risk as perceived by financial markets, even when controlling for the portion of life insurance in technical provisions. Similarly, the matching adjustment is linked to significantly higher credit risk sensitivities. Our results point out that due to discretionary decisions Solvency II figures can substantially deviate from a market-oriented, risk-based view on insurance companies’ risk situation.
In times of crisis, insurance companies may invest into riskier assets to benefit from expected price recoveries. Using daily stock market data for 34 European insurers, I investigate how a stock market contraction, as experienced during the Covid-19 pandemic, affects insurers’ decision on the allocation of their corporate bond portfolio. I find that insurers shift their portfolio holdings pro-cyclically towards lower credit risk assets in the first month of the market contraction. As the crisis progresses, I find evidence for counter-cyclical investment behavior by insurers, which can neither be explained by credit rating downgrades of held bonds nor by hedging with CDS derivatives. The observed counter-cyclical investment behavior of insurers could be beneficial for the financial system in attenuating price declines, but excessive risk-taking by insurance companies over longer periods can also reinforce stress in the system.
Macro-finance theory predicts that financial fragility builds up when volatility is low. This “volatility paradox’” challenges traditional systemic risk measures. I explore a new dimension of systemic risk, spillover persistence, which is the average time horizon at which a firm’s losses increase future risk in the financial system. Using firm-level data covering more than 30 years and 50 countries, I document that persistence declines when fragility builds up: before crises, during stock market booms, and when banks take more risks. In contrast, persistence increases with loss amplification: during crises and fire sales. These findings support key predictions of recent macrofinance models.
This paper investigates systemic risk in the insurance industry. We first analyze the systemic contribution of the insurance industry vis-à-vis other industries by applying 3 measures, namely the linear Granger causality test, conditional value at risk and marginal expected shortfall, on 3 groups, namely banks, insurers and non-financial companies listed in Europe over the last 14 years. We then analyze the determinants of the systemic risk contribution within the insurance industry by using balance sheet level data in a broader sample. Our evidence suggests that i) the insurance industry shows a persistent systemic relevance over time and plays a subordinate role in causing systemic risk compared to banks, and that ii) within the industry, those insurers which engage more in non-insurance-related activities tend to pose more systemic risk. In addition, we are among the first to provide empirical evidence on the role of diversification as potential determinant of systemic risk in the insurance industry. Finally, we confirm that size is also a significant driver of systemic risk, whereas price-to-book ratio and leverage display counterintuitive results.
We explore how personality traits are related to household borrowing behavior. Using survey data representative for the Netherlands, we consider the Big Five personality traits (openness, conscientiousness, agreeableness, extraversion and neuroticism), as well as the belief that one is master of one’s fate (locus of control). We hypothesize that personality traits can complement as well as substitute financial knowledge of a household. We present three sets of results. First, we find that personality traits are positively correlated with borrowing expectations. Locus of control, extraversion and agreeableness are correlated with informal borrowing expectations, which is the expectation that one can borrow from family and friends. With respect to expectations on the approval of a formal loan application, it is locus of control and conscientiousness that are positively associated. Effect sizes are large and economically meaningful. Second, we find that personality traits are important for borrowing constraints. A more internal locus of control and higher neuroticism are correlated with being denied for credit, as well as discouraged borrowing. Our third set of results reports findings on personality traits and loan regret, and how traits are correlated with dealing with loan troubles. Many households in our sample express regret (21%), but more open, more agreeable and more neurotic individuals are more likely to express regret. Our results are not driven by financial knowledge, time preferences or risk attitudes. Overall these findings imply that non-cognitive traits are important for borrowing behavior of households.
The Federal Reserve has been publishing federal funds rate prescriptions from Taylor rules in its Monetary Policy Report since 2017. The signals from the rules aligned with Fed action on many occasions, but in some cases the Fed opted for a different route. This paper reviews the implications of the rules during the coronavirus pandemic and the subsequent inflation surge and derives projections for the future.
In 2020, the Fed took the negative prescribed rates, which were far below the effective lower bound on the nominal interest rate, as support for extensive and long-lasting quantitative easing. Yet, the calculations overstate the extent of the constraint, because they neglect the supply side effects of the pandemic.
The paper proposes a simple model-based adjustment to the resource gap used by the rules for 2020. In 2021, the rules clearly signaled the need for tightening because of the rise of inflation, yet the Fed waited until spring 2022 to raise the federal funds rate. With the decline of inflation over the course of 2023, the rules’ prescriptions have also come down. They fall below the actual federal funds rate target range in 2024. Several caveats concerning the projections of the interest rate prescriptions are discussed.
This paper addresses the need for transparent sustainability disclosure in the European Auto Asset-Backed Securities (ABS) market, a crucial element in achieving the EU's climate goals. It proposes the use of existing vehicle identifiers, the Type Approval Number (TAN) and the Type-Variant-Version Code (TVV), to integrate loan-level data with sustainability-related vehicle information from ancillary sources. While acknowledging certain challenges, the combined use of TAN and TVV is the optimal solution to allow all stakeholders to comprehensively assess the environmental characteristics of securitised exposure pools in terms of data protection, matching accuracy, and cost-effectiveness.
SAFE Update February 2024
(2024)
In this study, we unpack the ESG ratings of four prominent agencies in Europe and find that (i) each single E, S, G pillar explains the overall ESG score differently,(ii) there is a low co-movement between the three E, S, G pillars and (iii) there are specific ESG Key Performance Indicators (KPIs) that are driving these ratings more than others. We argue that such discrepancies might mislead firms about their actual ESG status, potentially leading to cherry-picking areas for improvement, thus raising questions about the accuracy and effectiveness of ESG evaluations in both explaining sustainability and driving capital toward sustainable companies.
We document the individual willingness to act against climate change and study the role of social norms in a large sample of US adults. Individual beliefs about social norms positively predict pro-climate donations, comparable in strength to universal moral values and economic preferences such as patience and reciprocity. However, we document systematic misperceptions of social norms. Respondents vastly underestimate the prevalence of climate-friendly behaviors and norms. Correcting these misperceptions in an experiment causally raises individual willingness to act against climate change as well as individual support for climate policies. The effects are strongest for individuals who are skeptical about the existence and threat of global warming.
Despite a number of helpful changes, including the adoption of an inflation target, the Fed’s monetary policy strategy proved insufficiently resilient in recent years. While the Fed eased policy appropriately during the pandemic, it fell behind the curve during the post-pandemic recovery. During 2021, the Fed kept easing policy while the inflation outlook was deteriorating and the economy was growing considerably faster than the economy’s natural growth rate—the sum of the Fed’s 2% inflation goal and the growth rate of potential output.
The resilience of the Fed’s monetary policy strategy could be enhanced, and such errors be avoided with guidance from a simple natural growth targeting rule that prescribes that the federal funds rate during each quarter be raised (cut) when projected nominal income growth exceeds (falls short) of the economy’s natural growth rate. An illustration with real-time data and forecasts since the early 1990s shows that Fed policy has not persistently deviated from this simple rule with the notable exception of the period coinciding with the Fed’s post-pandemic policy error.
We study the many implications of the Eurosystem collateral framework for corporate bonds. Using data on the evolving collateral eligibility list, we identify the first inclusion dates of bonds and issuers and use these events to find that the increased supply and demand for pledgeable collateral following eligibility (a) increases activity in the corporate securities lending market, (b) lowers eligible bond yields, and (c) affects bond liquidity. Thus, corporate bond lending relaxes the constraint of limited collateral supply and thereby improves market functioning.
This paper empirically analyses whether post-global financial crisis regulatory reforms have created appropriate incentives to voluntarily centrally clear over-the-counter (OTC) derivative contracts. We use confidential European trade repository data on single-name sovereign credit default swap (CDS) transactions and show that both seller and buyer manage counterparty exposures and capital costs, strategically choosing to clear when the counterparty is riskier. The clearing incentives seem particularly responsive to seller credit risk, which is in line with the notion that counterparty credit risk (CCR) is asymmetric in CDS contracts. The riskiness of the underlying reference entity also impacts the decision to clear as it affects both CCR capital charges for OTC contracts and central counterparty clearing house (CCP) margins for cleared contracts. Lastly, we find evidence that when a transaction helps netting positions with the CCP and hence lower margins, the likelihood of clearing is higher.
Why does the schooling gap close while the wage gap persists across country income comparisons?
(2023)
The schooling gap diminishes because the services sector becomes more pronounced for high-income countries, and the paid hours gap closes. Although gender wage inequality persists across country income groups, differences in schooling years between females and males diminish. We assemble a novel dataset, calibrate a general equilibrium, multi-sector, -gender, and -production technology model, and show that gender-specific sectoral comparative advantages explain the paid hours and schooling gap decline from low- to high-income economies even when the wage gap persists. Additionally, our counterfactual analyses indicate that consumption subsistence and production share heterogeneity across both income groups and genders are essential to explain the co-decline of the schooling and paid hours gaps. Our results highlight effective mechanisms for policies aiming to reduce gender inequality in schooling and suggest that the schooling gap decline and the de-invisibilization of female paid work observed in high-income countries are linked by structural sector movements instead of wage inequality reductions.
In its first ten years (2014-2023), the banking union was successful in its prudential agenda but failed spectacularly in its underlying objective: establishing a single banking market in the euro area. This goal is now more important than ever, and easier to attain than at any time in the last decade. To make progress, cross-border banks should receive a specific treatment within general banking union legislation. Suggestions are made on how to make such regulatory carve-out effective and legally sound.