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This chapter analyzes the risk and return characteristics of investments in artists from the Middle East and Northern Africa (MENA) region over the sample period 2000 to 2012. With hedonic regression modeling we create an annual index that is based on 3,544 paintings created by 663 MENA artists. Our empirical results prove that investing in such a hypothetical index provides strong financial returns. While the results show an exponential growth in sales since 2006, the geometric annual return of the MENA art index is a stable13.9 percent over the whole period. We conclude that investing in MENA paintings would have been profitable but also note that we examined the performance of an emerging art market that has only seen an upward trend without any correction, yet.
The record-breaking prices observed in the art market over the last three years raise the question of whether we are experiencing a speculative bubble. Given the difficulty to determine the fundamental value of artworks, we apply a right-tailed unit root test with forward recursive regressions (SADF test) to detect explosive behaviors directly in the time series of four different art market segments (“Impressionist and Modern”, “Post-war and Contemporary”, “American”, and “Latin American”) for the period from 1970 to 2013. We identify two historical speculative bubbles and find an explosive movement in today’s “Post-war and Contemporary” and “American” fine art market segments.
This paper investigates the impact of news media sentiment on financial market returns and volatility in the long-term. We hypothesize that the way the media formulate and present news to the public produces different perceptions and, thus, incurs different investor behavior. To analyze such framing effects we distinguish between optimistic and pessimistic news frames. We construct a monthly media sentiment indicator by taking the ratio of the number of newspaper articles that contain predetermined negative words to the number of newspaper articles that contain predetermined positive words in the headline and/or the lead paragraph. Our results indicate that pessimistic news media sentiment is positively related to global market volatility and negatively related to global market returns 12 to 24 months in advance. We show that our media sentiment indicator reflects very well the financial market crises and pricing bubbles over the past 20 years.
Telecommunications companies traditionally offer several tariffs from which their customers can choose the tariff that best suits their preferences. Yet, customers sometimes make choices that are not optimal for them because they do not minimize their bill for a certain usage amount. We show in this paper that companies should be very concerned about choices in which customers pick tariffs that are too small for them because they lead to a significant increase in customers churn. In contrast, this is not the case if customers choose tariffs that are too big for them. The reason is that in particular flat-rates provide customers with the additional benefit that they guarantee a constant bill amount that consumption can be enjoyed more freely because all costs are already accounted for.
In many markets, design is one of the key factors in determining a product’s success. The present research offers insights into the role of design for the success of cars, and offers procedures to measure the quality of the designs objectively. The authors show that visual design plays a major role in a product’s success in the automobile market. In the study, two visual design aspects were already sufficient to significantly improve traditional sales forecasting models for cars. Visual prototypicality and visual complexity both had a positive impact on sales, and designs that were perceived as both prototypical and complex were the ones that displayed the best results. Most design evaluation used to be based on subjective measures, but the researcher applied a new, objective procedure to measure prototypicality and complexity. While the latter was detected by the disk space needed by the compressed image file, the new approach for measuring prototypicality was even more sophisticated. It relied on the technique of image morphing. Morphing is a technique that allows the construction of a visual synthesis – or average picture – from a number of individual pictures. Once a car morph is developed, one can determine the visual similarity of different car models to the morph in order to obtain its prototypicality. In principle, this procedure can be automated completely, and including a large number of versions is possible. These measures therefore seem suitable for supporting design decision processes in practice.
Markets are central to modern society, so their failures can have devastating effects. Here, we examine a prominent failure: price bubbles. We propose that bubbles are affected by ethnic homogeneity in the market and can be thwarted by diversity. Using experimental markets in Southeast Asia and North America, we find a marked difference: Market prices fit true values 58% better in diverse markets. In homogenous markets, overpricing is higher and traders’ errors are more correlated than in diverse markets. The findings suggest that price bubbles arise not only from individual errors or financial conditions, but also from the social context of decision making. Informing public discussion, our findings suggest that diversity facilitates friction that enhances deliberation and upends conformity.
On 23 July 2014, the U.S. Securities and Exchange Commission (SEC) passed the “Money Market Reform: Amendments to Form PF ,” designed to prevent investor runs on money market mutual funds such as those experienced in institutional prime funds following the bankruptcy of Lehman Brothers. The present article evaluates the reform choices in the U.S. and draws conclusions for the proposed EU regulation of money market funds.
This paper investigates extensions of the method of endogenous gridpoints (ENDGM) introduced by Carroll (2006) to higher dimensions with more than one continuous endogenous state variable. We compare three different categories of algorithms: (i) the conventional method with exogenous grids (EXOGM), (ii) the pure method of endogenous gridpoints (ENDGM) and (iii) a hybrid method (HYBGM). ENDGM comes along with Delaunay interpolation on irregular grids. Comparison of methods is done by evaluating speed and accuracy. We find that HYBGM and ENDGM both dominate EXOGM. In an infinite horizon model, ENDGM also always dominates HYBGM. In a finite horizon model, the choice between HYBGM and ENDGM depends on the number of gridpoints in each dimension. With less than 150 gridpoints in each dimension ENDGM is faster than HYBGM, and vice versa. For a standard choice of 25 to 50 gridpoints in each dimension, ENDGM is 1.4 to 1.7 times faster than HYBGM in the finite horizon version and 2.4 to 2.5 times faster in the infinite horizon version of the model.
Europe's debt crisis casts doubt on the effectiveness of fiscal austerity in highly-integrated economies. Closed-economy models overestimate its effectiveness, because they underestimate tax-base elasticities and ignore cross-country tax externalities. In contrast, we study tax responses to debt shocks in a two-country model with endogenous utilization that captures those externalities and matches the capital-tax-base elasticity. Quantitative results show that unilateral capital tax hikes cannot restore fiscal solvency in Europe, and have large negative (positive) effects at "home" ("abroad"). Restoring solvency via either Nash competition or Cooperation reduces (increases) capital (labor) taxes significantly, and leaves countries with larger debt shocks preferring autarky.
Riley (1979)'s reactive equilibrium concept addresses problems of equilibrium existence in competitive markets with adverse selection. The game-theoretic interpretation of the reactive equilibrium concept in Engers and Fernandez (1987) yields the Rothschild-Stiglitz (1976)/Riley (1979) allocation as an equilibrium allocation, however multiplicity of equilibrium emerges. In this note we imbed the reactive equilibrium's logic in a dynamic market context with active consumers. We show that the Riley/Rothschild-Stiglitz contracts constitute the unique equilibrium allocation in any pure strategy subgame perfect Nash equilibrium.
This paper investigates the role of monetary policy in the collapse in the long-term real interest rates in the decade before the onset of the financial crisis using a sample of five advanced economies (United States, United Kingdom, the euro area, Sweden and Canada). The results from an estimated panel VAR with monthly data show that, while monetary policy shocks had negligible effects on long-term real interest rates, shocks to the long-term real interest rates had a one-to-one effect on the short nominal rate.
We analyze the differential impact of domestic and foreign monetary policy on the local supply of bank credit in domestic and foreign currencies. We analyze a novel, supervisory dataset from Hungary that records all bank lending to firms including its currency denomination. Accounting for time-varying firm-specific heterogeneity in loan demand, we find that a lower domestic interest rate expands the supply of credit in the domestic but not in the foreign currency. A lower foreign interest rate on the other hand expands lending by lowly versus highly capitalized banks relatively more in the foreign than in the domestic currency.
Are rules and boundaries sufficient to limit harmful central bank discretion? Lessons from Europe
(2014)
Marvin Goodfriend’s (2014) insightful, informative and provocative work explains concisely and convincingly why the Fed needs rules and boundaries. This paper reviews the broader institutional design problem regarding the effectiveness of the central bank in practice and confirms the need for rules and boundaries. The framework proposed for improving the Fed incorporates key elements that have already been adopted in the European Union. The case of ELA provision by the ECB and the Central Bank of Cyprus to Marfin-Laiki Bank during the crisis, however, suggests that the existence of rules and boundaries may not be enough to limit harmful discretion. During a crisis, novel interpretations of the legal authority of the central bank may be introduced to create a grey area that might be exploited to justify harmful discretionary decisions even in the presence of rules and boundaries. This raises the question how to ensure that rules and boundaries are respected in practice
This chapter discusses whether and how 'new quantitative trade models' (NQTMs) can be fruitfully applied to quantify the welfare effects of trade liberalization, thus shedding light on the trade-related effects of further European integration. On the one hand, it argues that NQTMs have indeed the potential of being used to supplement traditional 'computable general equilibrium' (CGE) analysis thanks to their tight connection between theory and data, appealing micro-theoretical foundations, and enhanced attention to the estimation of structural parameters. On the other hand, further work is still needed in order to fully exploit such potential.
What would be the economic effects of the UK leaving the European Union on living standards of British people? We focus on the effects of trade on welfare net of lower fiscal transfers to the EU. We use a standard quantitative static general equilibrium trade model with multiple sectors, countries and intermediates, as in Costinot and Rodriguez-Clare (2013). Static losses range between 1.13% and 3.09% of GDP, depending on the assumptions used in our counterfactual scenarios. Including dynamic effects could more than double such losses.
Especially in developing countries credit constraints are often perceived as one of the most important market frictions constraining firm innovation and growth. Huge amounts of public money are being devoted to the removal of such constraints but their effectiveness is still subject to an intense policy debate. This paper contributes to this debate by analysing the effects of the Brazilian Development Bank (BNDES) loans. It finds that, before receiving BNDES support, granted firms are indeed more credit constrained than comparable non-granted firms. It also finds that BNDES support allows granted firms to achieve the same level of performance as similar non-granted firms that are not credit constrained. However, it does not allow granted firms to outperform similar non-granted ones.
his paper distils three lessons for bank regulation from the experience of the 2009-12 euro-area financial crisis. First, it highlights the key role that sovereign debt exposures of banks have played in the feedback loop between bank and fiscal distress, and inquires how the regulation of banks’ sovereign exposures in the euro area should be changed to mitigate this feedback loop in the future. Second, it explores the relationship between the forbearance of non-performing loans by European banks and the tendency of EU regulators to rescue rather than resolving distressed banks, and asks to what extent the new regulatory framework of the euro-area “banking union” can be expected to mitigate excessive forbearance and facilitate resolution of insolvent banks. Finally, the paper highlights that capital requirements based on the ratio of Tier-1 capital to banks’ risk-weighted assets were massively gamed by large banks, which engaged in various forms of regulatory arbitrage to minimize their capital charges while expanding leverage. This argues in favor of relying on a set of simpler and more robust indicators to determine banks’ capital shortfall, such as book and market leverage ratios.
Has economic research been helpful in dealing with the financial crises of the early 2000s? On the whole, the answer is negative, although there are bright spots. Economists have largely failed to predict both crises, largely because most of them were not analytically equipped to understand them, in spite of their recurrence in the last 25 years. In the pre-crisis period, however, there have been important exceptions – theoretical and empirical strands of research that largely laid out the basis for our current thinking about financial crises. Since 2008, a flurry of new studies offered several different interpretations of the US crisis: to some extent, they point to potentially complementary factors, but disagree on their relative importance, and therefore on policy recommendations. Research on the euro debt crisis has so far been much more limited: even Europe-based researchers – including CEPR ones – have often directed their attention more to the US crisis than to that occurring on their doorstep. In terms of impact on policy and regulatory reform, the record is uneven. On the one hand, the swift and massive liquidity provision by central banks in the wake of both crises is, at least partly, to be credited to previous research on the role of central banks as lenders of last resort in crises and on the real effects of bank lending and monetary policy. On the other hand, economists have had limited impact on the reform of prudential and security market regulation. In part, this is due to their neglect of important regulatory choices, which policy-makers are therefore left to take without the guidance of academic research-based analysis.
We outline a procedure for consistent estimation of marginal and joint default risk in the euro area financial system. We interpret the latter risk as the intrinsic financial system fragility and derive several systemic fragility indicators for euro area banks and sovereigns, based on CDS prices. Our analysis documents that although the fragility of the euro area banking system had started to deteriorate before Lehman Brothers' file for bankruptcy, investors did not expect the crisis to affect euro area sovereigns' solvency until September 2008. Since then, and especially after November 2009, joint sovereign default risk has outpaced the rise of systemic risk within the banking system.
I analyze a critical illness insurance in a consumption-investment model over the life cycle. I solve a model with stochastic mortality risk and health shock risk numerically. These shocks are interpreted as critical illness and can negatively affect the expected remaining lifetime, the health expenses, and the income. In order to hedge the health expense effect of a shock, the agent has the possibility to contract a critical illness insurance. My results highlight that the critical illness insurance is strongly desired by the agents. With an insurance profit of 20%, nearly all agents contract the insurance in the working stage of the life cycle and more than 50% of the agents contract the insurance during retirement. With an insurance profit of 200%, still nearly all working agents contract the insurance, whereas there is little demand in the retirement stage.