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Social Security rules that determine retirement, spousal, and survivor benefits, along with benefit adjustments according to the age at which these are claimed, open up a complex set of financial options for household decisions. These rules influence optimal household asset allocation, insurance, and work decisions, subject to life cycle demographic shocks, such as marriage, divorce, and children. Our model-based research generates a wealth profile and a low and stable equity fraction consistent with empirical evidence. We confirm predictions that wives will claim retirement benefits earlier than husbands, while life insurance is mainly purchased by younger men. Our policy simulations imply that eliminating survivor benefits would sharply reduce claiming differences by sex while dramatically increasing men’s life insurance purchases.
We study a model where some investors ("hedgers") are bad at information processing, while others ("speculators") have superior information-processing ability and trade purely to exploit it. The disclosure of financial information induces a trade externality: if speculators refrain from trading, hedgers do the same, depressing the asset price. Market transparency reinforces this mechanism, by making speculators' trades more visible to hedgers. As a consequence, issuers will oppose both the disclosure of fundamentals and trading transparency. Issuers may either under- or over-provide information compared to the socially efficient level if speculators have more bargaining power than hedgers, while they never under-provide it otherwise. When hedgers have low financial literacy, forbidding their access to the market may be socially efficient.
In this paper we investigate the implications of providing loan officers with a compensation structure that rewards loan volume and penalizes poor performance versus a fixed wage unrelated to performance. We study detailed transaction information for more than 45,000 loans issued by 240 loan officers of a large commercial bank in Europe. We examine the three main activities that loan officers perform: monitoring, originating, and screening. We find that when the performance of their portfolio deteriorates, loan officers increase their effort to monitor existing borrowers, reduce loan origination, and approve a higher fraction of loan applications. These loans, however, are of above-average quality. Consistent with the theoretical literature on multitasking in incomplete contracts, we show that loan officers neglect activities that are not directly rewarded under the contract, but are in the interest of the bank. In addition, while the response by loan officers constitutes a rational response to a time allocation problem, their reaction to incentives appears myopic in other dimensions.
This is a chapter for a forthcoming volume Oxford Handbook of Financial Regulation (Oxford University Press 2014) (eds. Eilís Ferran, Niamh Moloney, and Jennifer Payne). It provides an overview of EU financial regulation from the first banking directive up until its most recent developments in the aftermath of the financial crisis, focusing on the multiple layers of multi-level governance and their characteristic conceptual difficulties. Therefore the paper discusses the need to accommodate cross-border capital flows following from the EU internal market and the resulting regulatory strategies. This includes a brief overview of the principle of home country control and the ensuing Financial Services Action Plan. Dealing with the accommodation of cross-border capital flows and their regulation necessarily require an orchestration of the underlying supervisory structures, which is therefore also discussed. In the aftermath of the financial crisis of 2007-09 an additional aspect of necessary orchestration has emerged, that is the need to control systemic risk. Specific attention is paid to microprudential supervision by the newly established European Supervisory Authorities and macroprudential supervision in the European Banking Union, the latter’s underlying drivers and the accompanying Single Supervisory Mechanism, including the SSM’s institutional framework as well as the consideration of its rationales and the Single Resolution Mechanism closely linked to it.
US data and new stockholding data from fifteen European countries and China exhibit a common pattern: stockholding shares increase in household income and wealth. Yet, there is a multitude of numbers to match through models. Using a single utility function across households (parsimony), we suggest a strategy for fitting stockholding numbers, while replicating that saving rates increase in wealth, too. The key is introducing subsistence consumption to an Epstein-Zin-Weil utility function, creating endogenous risk-aversion differences across rich and poor. A closed-form solution for the model with insurable labor-income risk serves as calibration guide for numerical simulations with uninsurable labor-income risk.
n a contribution prepared for the Athens Symposium on “Banking Union, Monetary Policy and Economic Growth”, Otmar Issing describes forward guidance by central banks as the culmination of the idea of guiding expectations by pure communication. In practice, he argues, forward guidance has proved a misguided idea. What is presented as state of the art monetary policy is an example of pretence of knowledge. Forward guidance tries to give the impression of a kind of rule-based monetary policy. De facto, however, it is an overambitious discretionary approach which, to be successful, would need much more (or rather better) information than is currently available. In Issing's view, communication must be clear and honest about the limits of monetary policy in a world of uncertainty.
Francisco Suárez (1548-1617) and Rodrigo Arriaga (1592-1667) on the state of innocence and community
(2014)
Recent scholarship on late-scholastic thought has stressed a Jesuit discontinuity from Thomism. While Aquinas’ Aristotelian thesis located the political sphere in the state of innocence, Jesuit thought on community formation is said to have referred to ‘fallen’ and ‘pure’ nature. In this piece, I trace one particular narrative: In the hypothetical, lasting state of innocence (if original sin had not occurred), Aquinas identified the political community, but not the institution of the sacraments. Two celebrated Jesuit scholastics, Francisco Suárez and Rodrigo Arriaga, challenged the latter claim and defended the naturalness of spiritual alongside temporal power. This effectively allowed them to connect ‘nature’ to ‘utility’ and ‘necessity’ without tying their claims to the supernatural teleology. To them, the state of innocence remained relevant for politics, albeit in a way that challenged the Thomist account.
Social impact bonds are a special type of bond whose purpose is to provide long term funds to projects with a social impact. Especially in the UK and in the US these bonds are increasingly being used to raise funds to finance government projects. Their return depends on the social improvements achieved. Especially in times of crisis, governments lack funds to prevent the social consequences of recessions. Faia argues that the European Union should develop an equivalent to the British Social Finance Ltd. to finance projects for social improvement.
The long-run consumption risk (LRR) model is a promising approach to resolve prominent asset pricing puzzles. The simulated method of moments (SMM) provides a natural framework to estimate its deep parameters, but caveats concern model solubility and weak identification. We propose a two-step estimation strategy that combines GMM and SMM, and for which we elicit informative macroeconomic and financial moment matches from the LRR model structure. In particular, we exploit the persistent serial correlation of consumption and dividend growth and the equilibrium conditions for market return and risk-free rate, as well as the model-implied predictability of the risk-free rate. We match analytical moments when possible and simulated moments when necessary and determine the crucial factors required for both identification and reasonable estimation precision. A simulation study – the first in the context of long-run risk modeling – delineates the pitfalls associated with SMM estimation of a non-linear dynamic asset pricing model. Our study provides a blueprint for successful estimation of the LRR model.
In this paper we argue that very high marginal labor income tax rates are an effective tool for social insurance even when households have preferences with high labor supply elasticity, make dynamic savings decisions, and policies have general equilibrium effects. To make this point we construct a large scale Overlapping Generations Model with uninsurable labor productivity risk, show that it has a wealth distribution that matches the data well, and then use it to characterize fiscal policies that achieve a desired degree of redistribution in society. We find that marginal tax rates on the top 1% of the earnings distribution of close to 90% are optimal. We document that this result is robust to plausible variation in the labor supply elasticity and holds regardless of whether social welfare is measured at the steady state only or includes transitional generations.
How much additional tax revenue can the government generate by increasing labor income taxes? In this paper we provide a quantitative answer to this question, and study the importance of the progressivity of the tax schedule for the ability of the government to generate tax revenues. We develop a rich overlapping generations model featuring an explicit family structure, extensive and intensive margins of labor supply, endogenous accumulation of labor market experience as well as standard intertemporal consumption-savings choices in the presence of uninsurable idiosyncratic labor productivity risk. We calibrate the model to US macro, micro and tax data and characterize the labor income tax Laffer curve under the current choice of the progressivity of the labor income tax code as well as when varying progressivity. We find that more progressive labor income taxes significantly reduce tax revenues. For the US, converting to a flat tax code raises the peak of the Laffer curve by 6%, whereas converting to a tax system with progressivity similar to Denmark would lower the peak by 7%. We also show that, relative to a representative agent economy tax revenues are less sensitive to the progressivity of the tax code in our economy. This finding is due to the fact that labor supply of two earner households is less elastic (along the intensive margin) and the endogenous accumulation of labor market experience makes labor supply of females less elastic (around the extensive margin) to changes in tax progressivity.
Before the 2007–09 crisis, standard risk measurement methods substantially underestimated the threat to the financial system. One reason was that these methods didn’t account for how closely commercial banks, investment banks, hedge funds, and insurance companies were linked. As financial conditions worsened in one type of institution, the effects spread to others. A new method that more accurately accounts for these spillover effects suggests that hedge funds may have been central in generating systemic risk during the crisis.
How special are they? - Targeting systemic risk by regulating shadow banking : (October 5, 2014)
(2014)
This essay argues that at least some of the financial stability concerns associated with shadow banking can be addressed by an approach to financial regulation that imports its functional foundations more vigorously into the interpretation and implementation of existing rules. It shows that the general policy goals of prudential banking regulation remain constant over time despite dramatic transformations in the financial and technological landscape. Moreover, these overarching policy goals also legitimize intervention in the shadow banking sector. On these grounds, this essay encourages a more normative construction of available rules that potentially limits both the scope for regulatory arbitrage and the need for ever more rapid updates and a constant increase in the complexity of the regulatory framework. By tying the regulatory treatment of financial innovation closely to existing prudential rules and their underlying policy rationales, the proposed approach potentially ends the socially wasteful race between hare and tortoise that signifies the relation between regulators and a highly dynamic industry. In doing so it does not generally hamper market participants’ efficient discoveries where disintermediation proves socially beneficial. Instead, it only weeds-out rent-seeking circumventions of existing rules and standards.
How special are they? - Targeting systemic risk by regulating shadow banking : (October 5, 2014)
(2014)
This essay argues that at least some of the financial stability concerns associated with shadow banking can be addressed by an approach to financial regulation that imports its functional foundations more vigorously into the interpretation and implementation of existing rules. It shows that the general policy goals of prudential banking regulation remain constant over time despite dramatic transformations in the financial and technological landscape. Moreover, these overarching policy goals also legitimize intervention in the shadow banking sector. On these grounds, this essay encourages a more normative construction of available rules that potentially limits both the scope for regulatory arbitrage and the need for ever more rapid updates and a constant increase in the complexity of the regulatory framework. By tying the regulatory treatment of financial innovation closely to existing prudential rules and their underlying policy rationales, the proposed approach potentially ends the socially wasteful race between hare and tortoise that signifies the relation between regulators and a highly dynamic industry. In doing so it does not generally hamper market participants’ efficient discoveries where disintermediation proves socially beneficial. Instead, it only weeds-out rent-seeking circumventions of existing rules and standards.
In ‘Strafe für fremde Schuld’ Harald Maihold uncovered how a doctrine of surrogate punishment in the legal treatises of the Salamanca school gradually gave way to the principle of guilt. This meant that punishment eventually could only be inflicted upon a culprit and no longer upon an innocent. We will use René Girard’s philosophy of (the disruption of) scapegoat mechanisms and sacrifice to develop a coherent interpretation not only of how this institution of surrogate punishment functioned, how it selected its victims and the way it was legitimated, but also of the theology that formed its background. We argue that most of what surrogate punishment is about can be grasped in two words: sacrificial logic. The elimination of surrogation from criminal law would then correspond to the rejection of this logic, an evolution which could be interpreted as a desacralisation or secularisation of criminal law under the influence of the upcoming principle of guilt.
We characterize optimal redistribution in a dynastic family model with human capital. We show how a government can improve the trade-off between equality and incentives by changing the amount of observable human capital. We provide an intuitive decomposition for the wedge between human-capital investment in the laissez faire and the social optimum. This wedge differs from the wedge for bequests because human capital carries risk: its returns depend on the non-diversi
able risk of children's ability. Thus, human capital investment is encouraged more than bequests in the social optimum if human capital is a bad hedge for consumption risk.
A recent proposal by the Financial Stability Board (FSB) suggests a new risk capital buffer for globally operating systemically important financial institutions. The suggested metric, “Total Loss Absorbing Capacity“ (TLAC), is composed of Tier-1 capital and loss absorbing debt. In a crisis situation, “bail-in-able” debt is to be written down or converted into equity. Jan Krahnen argues that the credibility of bail-in, in the case of systemically important financial institutions, hinges crucially on the design of TLAC and the requirements that will be placed on loss absorbing “bail-in-able” debt.The fear of direct systemic consequences through bail-in could be overcome, if a holding ban were placed on the “bail-in-bonds” of financial institutions. The holding ban would stipulate that these bonds cannot be held by other institutions within the banking sector.
One of the leading methods of estimating the structural parameters of DSGE models is the VAR-based impulse response matching estimator. The existing asympotic theory for this estimator does not cover situations in which the number of impulse response parameters exceeds the number of VAR model parameters. Situations in which this order condition is violated arise routinely in applied work. We establish the consistency of the impulse response matching estimator in this situation, we derive its asymptotic distribution, and we show how this distribution can be approximated by bootstrap methods. Our methods of inference remain asymptotically valid when the order condition is satisfied, regardless of whether the usual rank condition for the application of the delta method holds. Our analysis sheds new light on the choice of the weighting matrix and covers both weakly and strongly identified DSGE model parameters. We also show that under our assumptions special care is needed to ensure the asymptotic validity of Bayesian methods of inference. A simulation study suggests that the frequentist and Bayesian point and interval estimators we propose are reasonably accurate in finite samples. We also show that using these methods may affect the substantive conclusions in empirical work.
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.
This paper examines the effect of imperfect labor market competition on the efficiency of compensation schemes in a setting with moral hazard, private information and risk-averse agents. Two vertically differentiated firrms compete for agents by offering contracts with fixed and variable payments. Vertical differentiation between firms leads to endogenous, type-dependent exit options for agents. In contrast to screening models with perfect competition, we find that existence of equilibria does not depend on whether the least-cost separating allocation is interim efficient. Rather, vertical differentiation allows the inferior firm to offer (cross-)subsidizing fixed payments even above the interim efficient level. We further show that the efficiency of variable pay depends on the degree of competition for agents: For small degrees of competition, low-ability agents are under-incentivized and exert too little effort. For large degrees of competition, high-ability agents are over-incentivized and bear too much risk. For intermediate degrees of competition, however, contracts are second-best despite private information.