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This paper studies the life cycle consumption-investment-insurance problem of a family. The wage earner faces the risk of a health shock that significantly increases his probability of dying. The family can buy term life insurance with realistic features. In particular, the available contracts are long term so that decisions are sticky and can only be revised at significant costs. Furthermore, a revision is only possible as long as the insured person is healthy. A second important and realistic feature of our model is that the labor income of
the wage earner is unspanned. We document that the combination of unspanned labor income and the stickiness of insurance decisions reduces the insurance demand significantly. This is because an income shock induces the need to reduce the insurance coverage, since premia become less affordable. Since such a reduction is costly and families anticipate these potential costs, they buy less protection at all ages. In particular, young families stay away from life insurance markets altogether.
Banks can deal with their liquidity risk by holding liquid assets (self-insurance), by participating in interbank markets (coinsurance), or by using flexible financing instruments, such as bank capital (risk-sharing). We use a simple model to show that undiversifiable liquidity risk, i.e. the liquidity risk that banks are unable to coinsure on interbank markets, represents an important risk factor affecting their capital structures. Banks facing higher undiversifiable liquidity risk hold more capital. We posit that empirically banks that are more exposed to undiversifiable liquidity risk are less active on interbank markets. Therefore, we test for the existence of a negative relationship between bank capital and interbank market activity and find support in a large sample of U.S. commercial banks.
The European Central Bank (ECB) has finalized its comprehensive assessment of the solvency of the largest banks in the euro area and on October 26 disclosed the results of this assessment. In the present paper, Acharya and Steffen compare the outcomes of the ECB's assessment to their own benchmark stress tests conducted for 39 publically listed financial institutions that are also included in the ECB's regulatory review. The authors identify a negative correlation between their benchmark estimates for capital shortfalls and the regulatory capital shortfall, but a positive correlation between their benchmark estimates for losses under stress both in the banking book and in the trading book. They conclude that the regulatory stress test outcomes are potentially heavily affected by discretion of national regulators in measuring what is capital, and especially the use of risk-weighted assets in calculating the prudential capital requirement.
he predictive likelihood is of particular relevance in a Bayesian setting when the purpose is to rank models in a forecast comparison exercise. This paper discusses how the predictive likelihood can be estimated for any subset of the observable variables in linear Gaussian state-space models with Bayesian methods, and proposes to utilize a missing observations consistent Kalman filter in the process of achieving this objective. As an empirical application, we analyze euro area data and compare the density forecast performance of a DSGE model to DSGE-VARs and reduced-form linear Gaussian models.
This article explores life insurance consumption in 31 European countries from 2003 to 2012 and aims to investigate the extent to which market transparency can affect life insurance demand. The cross-country evidence for the entire sample period shows that greater market transparency, which resolves asymmetric information, can generate a higher demand for life insurance. However, when considering the financial crisis period (2008-2012) separately, the results suggest a negative impact of enhanced market transparency on life insurance consumption. The mixed findings imply a trade-off between the reduction in adverse selection under greater market transparency and the possible negative effects on life insurance consumption during the crisis period due to more effective market discipline. Furthermore, this article studies the extent to which transparency can influence the reaction of life insurance demand to bad market outcomes: i.e., low solvency ratios or low profitability. The results indicate that the markets with bad outcomes generate higher life insurance demand under greater transparency compared to the markets that also experience bad outcomes but are less transparent.
This paper provides a systematic analysis of individual attitudes towards ambiguity, based on laboratory experiments. The design of the analysis allows to capture individual behavior across various levels of ambiguity, ranging from low to high. Attitudes towards risk and attitudes towards ambiguity are disentangled, providing pure measures of ambiguity aversion. Ambiguity aversion is captured in several ways, i.e. as a discount factor net of a risk premium, and as an estimated parameter in a generalized utility function. We find that ambiguity aversion varies across individuals, and with the level of ambiguity, being most prominent for intermediate levels. Around one third of subjects show no aversion, one third show maximum aversion, and one third show intermediate levels of ambiguity aversion, while there is almost no ambiguity seeking. While most theoretical work on ambiguity builds on maxmin expected utility, our results provide evidence that MEU does not adequately capture individual attitudes towards ambiguity for the majority of individuals. Instead, our results support models that allow for intermediate levels of ambiguity aversion. Moreover, we find risk aversion to be statistically unrelated to ambiguity aversion on average. Taken together, the results support the view that ambiguity is an important and distinct argument in decision making under uncertainty.
In the wake of the Global Financial Crisis that started in 2007, policymakers were forced to respond quickly and forcefully to a recession caused not by short-term factors, but rather by an over-accumulation of debt by sovereigns, banks, and households: a so-called “balance sheet recession.” Though the nature of the crisis was understood relatively early on, policy prescriptions for how to deal with its consequences have continued to diverge. This paper gives a short overview of the prescriptions, the remaining challenges and key lessons for monetary policy.
This paper makes a conceptual contribution to the effect of monetary policy on financial stability. We develop a microfounded network model with endogenous network formation to analyze the impact of central banks' monetary policy interventions on systemic risk. Banks choose their portfolio, including their borrowing and lending decisions on the interbank market, to maximize profit subject to regulatory constraints in an asset-liability framework. Systemic risk arises in the form of multiple bank defaults driven by common shock exposure on asset markets, direct contagion via the interbank market, and firesale spirals. The central bank injects or withdraws liquidity on the interbank markets to achieve its desired interest rate target. A tension arises between the beneficial effects of stabilized interest rates and increased loan volume and the detrimental effects of higher risk taking incentives. We find that central bank supply of liquidity quite generally increases systemic risk.
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.
Money is more than memory
(2014)
Impersonal exchange is the hallmark of an advanced society. One key institution for impersonal exchange is money, which economic theory considers just a primitive arrangement for monitoring past conduct in society. If so, then a public record of past actions — or memory — supersedes the function performed by money. This intriguing theoretical postulate remains untested. In an experiment, we show that the suggested functional equality between money and memory does not translate into an empirical equivalence. Monetary systems perform a richer set of functions than just revealing past behaviors, which proves to be crucial in promoting large-scale cooperation.