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In a production economy with trade in financial markets motivated by the desire to share labor-income risk and to speculate, we show that speculation increases volatility of asset returns and investment growth, increases the equity risk premium, and reduces welfare. Regulatory measures, such as constraints on stock positions, borrowing constraints, and the Tobin tax have similar effects on financial and macroeconomic variables. Borrowing limits and a financial transaction tax improve welfare because they substantially reduce speculative trading without impairing excessively risk-sharing trades.
Using merger announcements and applying methods from computational linguistics we find strong evidence that stock prices under-react to information in financial media. A one standard deviation increase in the media-implied probability of merger completion increases the subsequent 12-day return of a long-short merger strategy by 1.2 percentage points. Filtering out the 28% of announced deals with the lowest media-implied completion probability increases the annualized alpha from merger arbitrage by 9.3 percentage points. Our results are particularly pronounced when high-yield spreads are large and on days when only few merger deals are announced. We also document that financial media information is orthogonal to announcement day returns.
The recent financial crisis has demonstrated that a failure of Systemically Important Financial Institutions (SIFIs) could seriously damage the stability of the financial system. A precise and consistent definition of a SIFI is pivotal to ensure efficient and effective regulation of the global financial sector. This paper proposes a threefold test logic that allows to classify Financial Institutions as systemically important across the various industry segments.
The euro crisis was fueled by the diabolic loop between sovereign risk and bank risk, coupled with cross-border flight-to-safety capital flows. European Safe Bonds (ESBies), a union-wide safe asset without joint liability, would help to resolve these problems. We make three contributions. First, numerical simulations show that ESBies would be at least as safe as German bunds and approximately double the supply of euro safe assets when protected by a 30%-thick junior tranche. Second, a model shows how, when and why the two features of ESBies — diversification and seniority — can weaken the diabolic loop and its diffusion across countries. Third, we propose a step-by-step guide on how to create ESBies, starting with limited issuance by public or private-sector entities.
The term 'financialization' describes the phenomenon that commodity contracts are traded for purely financial reasons and not for motives rooted in the real economy. Recently, financialization has been made responsible for causing adverse welfare effects especially for low-income and low-wealth agents, who have to spend a large share of their income for commodity consumption and cannot participate in financial markets. In this paper we study the effect of financial speculation on commodity prices in a heterogeneous agent production economy with an agricultural and an industrial producer, a financial speculator, and a commodity consumer. While access to financial markets is always beneficial for the participating agents, since it allows them to reduce their consumption volatility, it has a decisive effect with respect to overall welfare effects who can trade with whom (but not so much what types of instruments can be traded).
A number of contributions to research on monetary policy have suggested that policy should be asymmetric near the lower bound on nominal interest rates. As inflation and economic activity decline, policy should ease more aggressively than it would in the absence of the lower bound. As activity recovers and inflation picks up, the central bank should act to keep interest rates lower for longer than without the bound. In this note, we investigate to what extent the policy easing implemented by the ECB since summer 2013 mirrors the rate recommendations of a simple policy rule or deviates from it in a way that indicates a “lower for longer” approach to policy near zero interest rates.
This paper compares the dynamics of the financial integration process as described by different empirical approaches. To this end, a wide range of measures accounting for several dimensions of integration is employed. In addition, we evaluate the performance of each measure by relying on an established international finance result, i.e., increasing financial integration leads to declining international portfolio diversification benefits. Using monthly equity market data for three different country groups (i.e., developed markets, emerging markets, developed plus emerging markets) and a dynamic indicator of international portfolio diversification benefits, we find that (i) all measures give rise to a very similar long-run integration pattern; (ii) the standard correlation explains variations in diversification benefits as well or better than more sophisticated measures. These Findings are robust to a battery of robustness checks.
Private equity fund managers are typically required to invest their own money alongside the fund. We examine how this coinvestment affects the acquisition strategy of leveraged buyout funds. In a simple model, where the investment and capital structure decisions are made simultaneously, we show that a higher coinvestment induces managers to chose less risky firms and use more leverage. We test these predictions in a unique sample of private equity investments in Norway, where the fund manager's taxable wealth is publicly available. Consistent with the model, portfolio company risk decreases and leverage ratios increase with the coinvestment fraction of the manager's wealth. Moreover, funds requiring a relatively high coinvestment tend to spread its capital over a larger number of portfolio firms, consistent with a more conservative investment policy.
Schätzwerte mittelfristiger Gleichgewichtszinsen mit der Methode nach Laubach und Williams (2003) werden inzwischen vielfach in der Diskussion um die Geld- und Fiskalpolitik zitiert. Unter anderem wurden sie von Summers (2014a) als Evidenz für eine säkulare Stagnation angeführt und von Yellen (2015) zur Rechtfertigung der Nullzinspolitik verwendet. In diesem Papier nehmen wir eine umfangreiche Untersuchung und Sensitivitätsanalyse dieser Schätzwerte für die Vereinigten Staaten, Deutschland und den Euro-Raum vor. Aufgrund der hohen Unsicherheit und Sensitivität, die mit den Schätzwerten mittelfristiger Gleichgewichtszinsen mit der Laubach-Williams-Methode und ähnlichen Ansätzen verbunden ist, sollten diese Schätzungen nicht den Ausschlag für entscheidende Weichenstellungen in der Geld- und Fiskalpolitik geben.