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We review arguments for and against reserve requirements and conclude that the main question is whether a distinction between money creation and intermediation can be made. We argue that such a distinction can be made in a money-in-advance economy and show that if the money-in-advance constraint is universally binding then reserve requirements on checkable accounts have no effect on intermediation. We then proceed to show that in a model in which trade is uncertain and sequential, a fractional reserve banking system gives rise to endogenous monetary shocks. These endogenous monetary shocks lead to fluctuations in capacity utilisation and waste. When the moneyin-advance constraint is universally binding, a 100% reserve requirement on checkable accounts can eliminate this waste.
Capturing the zero: a new class of zero-augmented distributions and multiplicative error processes
(2011)
We propose a novel approach to model serially dependent positive-valued variables which realize a non-trivial proportion of zero outcomes. This is a typical phenomenon in financial time series observed at high frequencies, such as cumulated trading volumes. We introduce a flexible point-mass mixture distribution and develop a semiparametric specification test explicitly tailored for such distributions. Moreover, we propose a new type of multiplicative error model (MEM) based on a zero-augmented distribution, which incorporates an autoregressive binary choice component and thus captures the (potentially different) dynamics of both zero occurrences and of strictly positive realizations. Applying the proposed model to high-frequency cumulated trading volumes of both liquid and illiquid NYSE stocks, we show that the model captures the dynamic and distributional properties of the data well and is able to correctly predict future distributions.
This paper addresses the open debate about the usefulness of high-frequency (HF) data in large-scale portfolio allocation. Daily covariances are estimated based on HF data of the S&P 500 universe employing a blocked realized kernel estimator. We propose forecasting covariance matrices using a multi-scale spectral decomposition where volatilities, correlation eigenvalues and eigenvectors evolve on different frequencies. In an extensive out-of-sample forecasting study, we show that the proposed approach yields less risky and more diversified portfolio allocations as prevailing methods employing daily data. These performance gains hold over longer horizons than previous studies have shown.
The direct financial impact of the financial crisis has been to deal a heavy blow to investment-based pensions; many workers lost a substantial portion of their retirement saving. The financial sector implosion produced an economic crisis for the rest of the economy via high unemployment and reduced labor earnings, which reduced household contributions to Social Security and some private pensions. Our research asks which types of individuals were most affected by these dual financial and economic shocks, and it also explores how people may react by changing their consumption, saving and investment, work and retirement, and annuitization decisions. We do so with a realistically calibrated lifecycle framework allowing for time-varying investment opportunities and countercyclical risky labor income dynamics. We show that households near retirement will reduce both short- and long-term consumption, boost work effort, and defer retirement. Younger cohorts will initially reduce their work hours, consumption, saving, and equity exposure; later in life, they will work more, retire later, consume less, invest more in stocks, save more, and reduce their demand for private annuities. Keywords: Financial Crisis , Household Finance , Cycle Portfolio Choice , Labor Supply Classification: D1, G11, G23, G35, J14, J26, J32
We make three points. First, the decade before the financial crisis in 2007 was characterized by a collapse in the yield on TIPS. Second, estimated VARs for the federal funds rate and the TIPS yield show that while monetary policy shocks had negligible effects on the TIPS yield, shocks to the latter had one-to-one effects on the federal funds rate. Third, these findings can be rationalized in a New Keynesian model.
There is ample empirical evidence documenting widespread financial illiteracy and limited pension knowledge. At the same time, the distribution of wealth is widely dispersed and many workers arrive on the verge of retirement with few or no personal assets. In this paper, we investigate the relationship between financial literacy and household net worth, relying on comprehensive measures of financial knowledge designed for a special module of the DNB (De Nederlandsche Bank) Household Survey. Our findings provide evidence of a strong positive association between financial literacy and net worth, even after controlling for many determinants of wealth. Moreover, we discuss two channels through which financial literacy might facilitate wealth accumulation. First, financial knowledge increases the likelihood of investing in the stock market, allowing individuals to benefit from the equity premium. Second, financial literacy is positively related to retirement planning, and the development of a savings plan has been shown to boost wealth. Overall, financial literacy, both directly and indirectly, is found to have a strong link to household wealth. JEL Classification: D91, D12, J26 Keywords: Financial Education, Savings and Wealth Accumulation, Retirement Preparation, Knowledge of Finance and Economics, Overconfidence, Stock Market Participation
This paper outlines a new method for using qualitative information to analyze the monetary policy strategy of central banks. Quantitative assessment indicators that are extracted from a central bank's public statements via the balance statistic approach are employed to estimate a Taylor-type rule. This procedure allows to directly capture a policymaker's assessments of macroeconomic variables that are relevant for its decision making process. As an application of the proposed method the monetary policy of the Bundesbank is re-investigated with a new dataset. One distinctive feature of the Bundesbank's strategy consisted of targeting growth in monetary aggregates. The analysis using the proposed method provides evidence that the Bundesbank indeed took into consideration monetary aggregates but also real economic activity and inflation developments in its monetary policy strategy since 1975. JEL Classification: E52, E58, N14 Keywords: Monetary Policy Rule, Statement Indicators, Bundesbank, Monetary Targeting
This paper analyzes the emergence of systemic risk in a network model of interconnected bank balance sheets. Given a shock to asset values of one or several banks, systemic risk in the form of multiple bank defaults depends on the strength of balance sheets and asset market liquidity. The price of bank assets on the secondary market is endogenous in the model, thereby relating funding liquidity to expected solvency - an important stylized fact of banking crises. Based on the concept of a system value at risk, Shapley values are used to define the systemic risk charge levied upon individual banks. Using a parallelized simulated annealing algorithm the properties of an optimal charge are derived. Among other things we find that there is not necessarily a correspondence between a bank's contribution to systemic risk - which determines its risk charge - and the capital that is optimally injected into it to make the financial system more resilient to systemic risk. The analysis has policy implications for the design of optimal bank levies. JEL Classification: G01, G18, G33 Keywords: Systemic Risk, Systemic Risk Charge, Systemic Risk Fund, Macroprudential Supervision, Shapley Value, Financial Network
Since World War II, direct stock ownership by households has largely been replaced by indirect stock ownership by financial institutions. We argue that tax policy is the driving force. Using long time-series from eight countries, we show that the fraction of household ownership decreases with measures of the tax benefits of holding stocks inside a pension plan. This finding is important for policy considerations on effective taxation and for financial economics research on the long-term effects of taxation on corporate finance and asset prices. JEL Classification: G10, G20, H22, H30 Keywords: Capital Gains Tax, Income Tax, Stock Ownership, Bond Ownership, Inflation, Bracket Creep, Pension Funds
Do firms buy their stock at bargain prices? : Evidence from actual stock repurchase disclosure
(2011)
We use new data from SEC filings to investigate how S&P 500 firms execute their open market repurchase programs. We find that smaller S&P 500 firms repurchase less frequently than larger firms, and at a price which is significantly lower than the average market price. Their repurchase activity is followed by a positive and significant abnormal return which lasts up to three months after the repurchase. These findings do not hold for large S&P 500 firms. Our interpretation is that small firms repurchase strategically, whereas the repurchase activity of large firms is more focused on the disbursement of free cash. JEL Classification: G14, G30, G35 Keywords: Stock Repurchases, Stock Buybacks, Payout Policy, Timing, Bid-Ask Spread, Liquidity
This paper studies the impact of the concentration of control, the type of controlling shareholder and the dividend tax preference of the controlling shareholder on dividend policy for a panel of 220 German firms over 1984-2005. While the concentration of control does not have an effect on the dividend payout, there is strong evidence that the type of controlling shareholder matters as family controlled firms have high dividend payouts whereas bank controlled firms have low dividend payouts. However, there is no evidence that the dividend preference of the large shareholder has an impact on the dividend decision. JEL Classification: G32, G35 Keywords: Dividend Policy, Payout Policy, Lintner Dividend Model, Tax Clientele Effects, Corporate Governance
"Buffer-stock" models of saving are now standard in the consumption literature. This paper builds theoretical foundations for rigorous understanding of the main features of such models, including the existence of a target wealth ratio and the proposition that aggregate consumption growth equals aggregate income growth in a small open economy populated by buffer stock savers. JEL Classification: D81, D91, E21 Keywords: Precautionary Saving, Buffer Stock Saving, Marginal Propensity to Consume, Permanent Income Hypothesis
This thesis consist of three chapters of which each investigates a topic from financial and monetary economics. In the first chapter a novel method to analyze the monetary policy of central banks is presented. In the second chapter (joint work with Professor Michael Binder, Goethe-University Frankfurt) the effects of conditional loan programs of the International Monetary Fund (IMF) on participating countries' output growth are investigated. In the third chapter (joint work with Professor Jan Pieter Krahnen, Goethe-University Frankfurt) a network model of interconnected bank balance sheets which gives rise to systemic risk is developed and used to analyze the implications of a bank levy related to banks' contribution to systemic risk. All three chapters give important insights to the policy design of macroeconomic institutions such as central banks, the IMF, and agencies charged with macroprudential supervision.
Measuring confidence and uncertainty during the financial crisis: evidence from the CFS survey
(2011)
The CFS survey covers individual situations of banks and other companies of the financial sector during the financial crisis. This provides a rare possibility to analyze appraisals, expectations and forecast errors of the core sector of the recent turmoil. Following standard ways of aggregating individual survey data, we first present and introduce the CFS survey by comparing CFS indicators of confidence and predicted confidence to ifo and ZEW indicators. The major contribution is the analysis of several indicators of uncertainty. In addition to well established concepts, we introduce innovative measures based on the skewness of forecast errors and on the share of ‘no response’ replies. Results show that uncertainty indicators fit quite well with pattern of real and financial time series of the time period 2007 to 2010. Business Sentiment , Financial Crisis , Survey Indicator , Uncertainty CFS working paper series, 2010, 18. Revised Version July 2011
I investigate the effect of transparency on the borrowing costs of Emerging Markets Economies. Transparency is measured by whether or not the countries publish the IMF Article IV Staff report and the Reports on the Observance of Standards and Codes (ROSC). Using difference-in-difference estimation, I study the effect on the sovereign credit spreads for 18 Emerging Market Economies over the period 1999-2007. I show that the effect of publishing the Article IV reports is negligible while publishing the ROSC matters, leading to a reduction in the spreads of over 15% in the samples 1999-2006 and 1999-2007. JEL Classification: F33, F34, G15 Keywords: Sovereign Bond Markets, Transparency, Emerging Market Economies
This paper outlines important lessons for monetary policy. In particular, the role of inflation targeting, which was much acclaimed prior to the financial crisis and since then has not lost much of its endorsement, is critically reviewed. Ignoring the relation between monetary policy and asset prices, as is the case in this monetary policy approach, can lead to financial instability. In contrast, giving, inter alia, monetary factors a role in central banks’ policy decisions, as is done in the ECB’s encompassing approach, helps prevent these potentially harmful side effects and thus allows for fostering financial stability. Finally, this paper makes a case against increasing the central banks’ inflation target. JEL Classification: E44, E52, E58 Keywords: Inflation Targeting, Asset Prices, Financial Stability, ECB
The focus of the discussion at the conference on September 23, 2004 was on the long-term impact on capital markets and pension systems. The speakers tried to identify the direction and magnitude of potential changes as well as the likelihood of an eventual asset meltdown. The conference's objective was to combine insights from academia with those from the financial community in order to provide a more comprehensive outlook on capital market developments. Conference Reader Nr. 2005/01
Conference Reader zur gemeinsam von Athansios Orphanides (Federal Reserve Board, Washington D.C.), John C. Williams (Federal Reserve Bank of San Francisco), Heinz Hermann (Deutsche Bundesbank), und Volker Wieland (Center for Financial Studies and Goethe University Frankfurt) organisierten Konferenz, die vom 30. - 31. August, 2003 in Eltville stattgefunden hat. Inhaltsverzeichnis: * Volker Wieland (Director Center for Financial Studies): Foreword * Hans Georg Fabritius (Member of the Executive Board of the Deutsche Bundesbank): Opening Remarks * Charles Goodhart (Norman Sosnow Professor of Banking and Finance at the London School of Economics and External Member of the Bank of England's Monetary Policy Commitee): After Dinner Speech * Paper Abstracts * List of Participants
Prepared by Christian Laux, Vienna University of Economics and Business & Center for Financial Studies (CFS) for the “Workshop on Liquidity Premium in Solvency II: Conceptual and Measurement Issues,” DNB Amsterdam, March 18, 2011. The insurance industry and the Committee of European Insurance and Occupational Pension Supervisors (CEIOPS) propose to add a liquidity premium to the risk-free rate when discounting liabilities in times of financial turmoil. The objective is to counterbalance adverse effects on regulatory capital due to a decrease in asset values caused by illiquidity in a crisis. As I argue in this note, although the motive might be sensible, the proposal to add a liquidity premium when discounting liabilities is not the right approach to tackle the problem.
The aim of this paper is to examine what has been the role of information provision to the market throughout the crisis. We consider two main sources of information to the market, financial statements and information provided by credit rating agencies. We examine how these sources of information work and the effectiveness of their disclosure process during the crisis. Contrary to the commonly held view, fair value accounting did not have a major impact on the crisis development and severity. However, the structure and lack of accountability of credit rating agencies had a profound impact on their incentives, which may have jeopardized the accuracy of the whole rating process. We claim that the crisis experience has changed the way we think about information as well as market discipline and discuss policy implications and proposals for regulation. JEL Classification: G01, G24, G28, M41, M48
In this paper we challenge the view that corporate bonds are always arm’s length debt. We analyze the effect of bond ratings on the stock price return to acquirers in M&A transactions, which tend to have significant effects on creditor wealth. We find acquirers abnormal returns to be higher if they are unrated, controlling for a wide variety of other effects identified in the literature. Tracing the difference in returns to distinct managerial decisions, we find that, everything else constant, rated firms increase their leverage in takeover transactions by less than their unrated counterparts. Consistent with a significant role for rating agencies, we find monitoring effects to be strongest when acquirer bonds are rated at the borderline between investment grade and junk. Finally, we are able to empirically exclude a large number of alternative explanations for the empirical regularities that we uncover. JEL Classification: G21, G24, G32, G34 Keywords: Acquisitions, Credit Ratings, Mergers and Acquisitions, Arm’s Length Debt, Abnormal Returns
In the microstructure literature, information asymmetry is an important determinant of market liquidity. The classic setting is that uninformed dedicated liquidity suppliers charge price concessions when incoming market orders are likely to be informationally motivated. In limit order book markets, however, this relationship is less clear, as market participants can switch roles, and freely choose to immediately demand or patiently supply liquidity by submitting either market or limit orders. We study the importance of information asymmetry in limit order books based on a recent sample of thirty German DAX stocks. We find that Hasbrouck’s (1991) measure of trade informativeness Granger-causes book liquidity, in particular that required to fill large market orders. Picking-off risk due to public news induced volatility is more important for top-of-the book liquidity supply. In our multivariate analysis we control for volatility, trading volume, trading intensity and order imbalance to isolate the effect of trade informativeness on book liquidity. JEL Classification: G14 Keywords: Price Impact of Trades , Trading Intensity , Dynamic Duration Models, Spread Decomposition Models , Adverse Selection Risk
We revisit the role of time in measuring the price impact of trades using a new empirical method that combines spread decomposition and dynamic duration modeling. Previous studies which have addressed the issue in a vector-autoregressive framework conclude that times when markets are most active are times when there is an increased presence of informed trading. Our empirical analysis based on recent European and U.S. data offers challenging new evidence. We find that as trade intensity increases, the informativeness of trades tends to decrease. This result is consistent with the predictions of Admati and Pfleiderer’s (1988) rational expectations model, and also with models of dynamic trading like those proposed by Parlour (1998) and Foucault (1999). Our results cast doubt on the common wisdom that fast markets bear particularly high adverse selection risks for uninformed market participants. JEL Classification: G10, C32 Keywords: Price Impact of Trades, Trading Intensity, Dynamic Duration Models, Spread Decomposition Models, Adverse Selection Risk
We present an intertemporal consumption model of consumer investment in financial literacy. Consumers benefit from such investment because their stock of financial literacy allows them to increase the returns on their wealth. Since literacy depreciates over time and has a cost in terms of current consumption, the model determines an optimal investment in literacy. The model shows that financial literacy and wealth are determined jointly, and are positively correlated over the life cycle. Empirically, the model leads to an instrumental variables approach, in which the initial stock of financial literacy (as measured by math performance in school) is used as an instrument for the current stock of literacy. Using microeconomic and aggregate data, we find a strong effect of financial literacy on wealth accumulation and national saving, and also show that ordinary least squares estimates underestate the impact of financial literacy on saving. JEL Classification: E2, D8, G1, J24 Keywords: Financial Literacy, Cognitive Abilities, Human Capital, Saving
We analytically show that a common across rich/poor individuals Stone-Geary utility function with subsistence consumption in the context of a simple two-asset portfolio-choice model is capable of qualitatively and quantitatively explaining: (i) the higher saving rates of the rich, (ii) the higher fraction of personal wealth held in risky assets by the rich, and (iii) the higher volatility of consumption of the wealthier. On the contrary, time-variant “keeping-up-with-the-Joneses” weighted average consumption which plays the role of moving benchmark subsistence consumption gives the same portfolio composition and saving rates across the rich and the poor, failing to reconcile the model with what micro data say. JEL Classification: G11, D91, E21, D81, D14, D11
The overvaluation hypothesis (Miller 1977) predicts that a) stocks are overvalued in the presence of short selling restrictions and that b) the overvaluation increases in the degree of divergence of opinion. We design an experiment that allows us to test these predictions in the laboratory. The results indicate that prices are higher with short selling constraints, but the overvaluation does not increase in the degree of divergence of opinion. We further find that trading volume is lower and bid-ask spreads are higher when short sale restrictions are imposed. JEL Classification: C92, G14 Keywords: Overvaluation Hypothesis , Short Selling Constraints , Divergence of Opinion
Regulations in the pre-Sarbanes–Oxley era allowed corporate insiders considerable flexibility in strategically timing their trades and SEC filings, for example, by executing several trades and reporting them jointly after the last trade. We document that even these lax reporting requirements were frequently violated and that the strategic timing of trades and reports was common. Event study abnormal re-turns are larger after reports of strategic insider trades than after reports of otherwise similar nonstrategic trades. Our results also imply that delayed reporting is detrimental to market efficiency and lend strong support to the more stringent trade reporting requirements established by the Sarbanes–Oxley Act. JEL Classification: G14, G30, G32 Keywords: Insider Trading , Directors' Dealings , Corporate Governance , Market Efficiency