Sustainable Architecture for Finance in Europe (SAFE)
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The eurozone remains in a deep, largely macro-economic crisis. A robust global economy and falling oil prices have supported Europe’s economy for some time, but by now it is clear that the eurozone will only be able to pull itself out of this crisis by means of more decisive action. One response, the recent easing of monetary policy by the European Central Bank (ECB), has, for the most part, been sharply and one-sidedly criticised in Germany. Monetary policy inaction seems to be the preferred option of many in Germany.
The authors discuss the following question: What would happen if the ECB failed to respond to the excessively low inflation and the weak economy? And what economic policy would be suitable under the current circumstances, if not monetary policy?
Euro area shadow banking activities in a low-interest-rate environment: a flow-of-funds perspective
(2016)
Very low policy rates as well as the substantial redesign of rules and supervisory institutions have changed background conditions for the Euro Area’s financial intermediary sector substantially. Both policy initiatives have been targeted at improving societal welfare. And their potential side effects (or costs) have been discussed intensively, in academic as well as policy circles. Very low policy rates (and correspondingly low market rates) are likely to whet investors’ risk taking incentives. Concurrently, the tightened regulatory framework, in particular for banks, increases the comparative attractiveness of the less regulated, so-called shadow banking sector. Employing flow-of-funds data for the Euro Area’s non-bank banking sector we take stock of recent developments in this part of the financial sector. In addition, we examine to which extent low interest rates have had an impact on investment behavior. Our results reveal a declining role of banks (and, simultaneously, an increase in non-bank banking). Overall intermediation activity, hence, has remained roughly at the same level. Moreover, our findings also suggest that non-bank banks have tended to take positions in riskier assets (particularly in equities). In line with this observation, balance-sheet based risk measures indicate a rise in sector-specific risks in the non-bank banking sector (when narrowly defined).
Non-bank (-balance sheet) based financial intermediation has become considerably more important over the last couple of decades. For the U.S., this trend has been discussed ever since the mid-1990s. As a consequence, traditional monetary transmission mechanisms, mainly operating through bank balance sheets, have apparently become less relevant. This in particular applies to the bank lending channel. Concurrently, recent theoretical and empirical work uncovered a "risk-taking channel" of monetary policy. This mechanism is not confined to traditional banks but has been found to operate also across the spectrum of financial intermediaries and intermediation devices, including securitization and collateralized lending/borrowing. In addition, recent empirical evidence suggests that the increasing importance of shadow-banking activities might have given rise to a so-called "waterbed effect". This is a mediating mechanisms, dampening or counteracting typically to be expected reactions to monetary policy impulses. Employing flow-of-funds data, we can document also for the Euro Area that a trend towards non-bank (not necessarily more 'market'-based) intermediation has occurred. This is, however, a fairly recent development, substantially weaker than in the U.S. Nonetheless, analyzing the response of Euro Area bank and nonbank financial intermediaries to monetary policy impulses, we find some notable behavioral differences between mainly deposit-funded and more 'market'-based financial intermediaries. We also detect, inter alia, the existence of a (still) fairly weak, but potentially policyrelevant, "waterbed" effect.
SAFE Newsletter : 2016, Q1
(2016)
his paper analyses the consumption-investment problem of a loss averse investor equipped with s-shaped utility over consumption relative to a time-varying reference level. Optimal consumption exceeds the reference level in good times and descend to the subsistence level in bad times. Accordingly, the optimal portfolio is dominated by a mean-variance component in good times and rebalanced more aggressively toward stocks in bad times. This consumption-investment strategy contrasts with customary portfolio theory and is consistent with several recent stylized facts about investors' behaviour. I also analyse the joint effect of loss aversion and persistence of the reference level on optimal choices. Finally, the strategy of the loss averse investor outperforms the conventional Merton-style strategies in bad times, but tend to be dominated by the conventional strategies in good times.
We introduce long-run investment productivity risk in a two-sector production economy to explain the joint behavior of macroeconomic quantities and asset prices. Long-run productivity risk in both sectors, for which we provide economic and empirical justification, acts as a substitute for shocks to the marginal efficiency of investments in explaining the equity premium and the stock return volatility differential between the consumption and the investment sector. Moreover, adding moderate wage rigidities allows the model to reproduce the empirically observed positive co-movement between consumption and investment growth.
This paper introduces endogenous preference evolution into a Lucas-type economy and explores its consequences for investors' trading strategy and the dynamics of asset prices. In equilibrium, investors herd and hold the same portfolio of risky assets which is biased toward stocks of sectors that produce a socially preferred good. Price-dividend ratios, expected returns and return volatility are all time varying. In this way, preference evolution helps rationalize the observed under-performance and local biases of investors' portfolios and many empirical regularities of stock returns such a time variation, the value-growth effect and stochastic volatility.
Keywords: Asset pricing, general equilibrium, heterogeneous investors, interdependent preferences, portfolio choice
JEL Classification: D51, D91, E20, G12
We investigate the role of competition on the outcome of Austrian Treasury auctions. Austria's EU accession led to an increase in the number of banks participating in treasury auctions. We use structural estimates of bidders' private values to examine the effect of increased competition on auction performance: We find that increased competition reduced bidder surplus substantially, but less than reduced form estimates would suggest. A significant component of the surplus reduction is due to more aggressive bidding. Counterfactuals establish that as competition increases, concerns regarding auction format play a smaller role.
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.
This paper describes cash equity markets in Germany and their evolution against the background of technological and regulatory transformation. The development of these secondary markets in the largest economy in Europe is first briefly outlined from a historical perspective. This serves as the basis for the description of the most important trading system for German equities, the Xetra trading system of Deutsche Börse AG. Then, the most important regulatory change for European and German equity markets in the last ten years is illustrated: the introduction of the Markets in Financial Instruments Directive (MiFID) in 2007. Its implications on equity trading in Germany are analyzed against the background of the current status of competition in Europe. Recent developments in European equity markets like the emergence of dark pools and algorithmic / high frequency trading are portrayed, before an outlook on new regulations (MiFID II, MiFIR) that will likely come into force in early 2018 will close the paper.
In the wake of the recent financial crisis, significant regulatory actions have been taken aimed at limiting risks emanating from trading in bank business models. Prominent reform proposals are the Volcker Rule in the U.S., the Vickers Report in the UK, and, based on the Liikanen proposal, the Barnier proposal in the EU. A major element of these reforms is to separate “classical” commercial banking activities from securities trading activities, notably from proprietary trading. While the reforms are at different stages of implementation, there is a strong ongoing discussion on what possible economic consequences are to be expected. The goal of this paper is to look at the alternative approaches of these reform proposals and to assess their likely consequences for bank business models, risk-taking and financial stability. Our conclusions can be summarized as follows: First, the focus on a prohibition of only proprietary trading, as envisaged in the current EU proposal, is inadequate. It does not necessarily reduce risk-taking and it likely crowds out desired trading activities, thereby negatively affecting financial stability. Second, there is potentially a better solution to limit excessive trading risk at banks in terms of potential welfare consequences: Trading separation into legally distinct or ring-fenced entities within the existing banking organizations. This kind of separation limits cross-subsidies between banking and proprietary trading and diminishes contagion risk, while still allowing for synergies across banking, non-proprietary trading and proprietary trading.
An important prerequisite for the efficiency of bail-in as a regulatory tool is that debt holders are able to bear the cost of a bail-in. Examining European banks’ subordinated debt we caution that households may be investors in bail-in able bonds. Since households do not fulfil the aforementioned prerequisite, we argue that European bank supervisors need to ensure that banks’ bail-in bonds are held by sophisticated investors. Existing EU market regulation insufficiently addresses mis-selling of bail-in instruments.
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.
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.
This paper investigates the potential implications of say on pay on management remuneration in Germany. We try to shed light on some key aspects by presenting quantitative data that allows us to gauge the pertinent effects of the German natural experiment that originates with the 2009 amendments to the Stock Corporation Act of 1965. In order to do this, we deploy a hand-collected data set for Germany's major firms (i.e. DAX 30), for the years 2006-2012. Rather than focusing exclusively on CEO remuneration we collected data for all members of the management board for the whole period under investigation. We observe that the compensation packages of management board members of Germany's DAX30-firms are quite closely linked to key performance measures. In addition, we find that salaries increase with the size of the company and that ownership concentration has no significant effect on compensation. Also, our findings suggest that the two-tier system seems to matter a lot when it comes to compensation. However, it would be misleading to state that we see no significant impact of the introduction of the German say on pay-regime. Our findings suggest that supervisory boards anticipate shareholder-behavior.
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.
The old boy network: the impact of professional networks on remuneration in top executive jobs
(2016)
We investigate the impact of social networks on earnings using a dataset of over 20,000 senior executives of European and US firms. The size of an individual's network of influential former colleagues has a large positive association with current remuneration. An individual at the 75th percentile in the distribution of connections could expect to have a salary nearly 20 per cent higher than an otherwise identical individual at the median. We use a placebo technique to show that our estimates reflect the causal impact of connections and not merely unobserved individual characteristics. Networks are more weakly associated with women's remuneration than with men's. This mainly reflects an interaction between unobserved individual characteristics and firm recruitment policies. The kinds of firm that best identify and advance talented women are less likely to give them access to influential networks than are firms that do the same for the most talented men.
The dynamics of entrepreneurial careers in high-tech ventures: experience, education, and exit
(2016)
We investigate the career dynamics of high-tech entrepreneurs by analyzing the exit choice of entrepreneurs: to found another firm, to become dependently employed, or to act as a business angel. Our detailed data resting on the CrunchBase online database indicate that founders stick with entrepreneurship as a serial entrepreneur or as an angel investor only in cases where the founder (1) had experience either in founding other startups or working for a startup, (2) had a ‘jack-of-all-trades’ education, or (3) achieved substantial financial success upon a venture capital exit transaction.