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The present paper proposes an overview of the existing literature covering several aspects related to environmental, social, and governance (ESG) factors. Specifically, we consider studies describing and evaluating ESG methodologies and those studying the impact of ESG on credit risk, debt and equity costs, or sovereign bonds. We further expand the topic of ESG research by including the strand of the literature focusing on the impact of climate change on financial stability, thus allowing us to also consider the most recent research on the impact of climate change on portfolio management.
In this paper, we investigate the relation between buildings' energy efficiency and the probability of mortgage default. To this end, we construct a novel panel dataset by combining Dutch loan-level mortgage information with provisional building energy ratings that are calculated by the Netherlands Enterprise Agency. By employing the Logistic regression and the extended Cox model, we find that buildings' energy efficiency is associated with lower likelihood of mortgage default. The results hold for a battery of robustness checks. Additional findings indicate that credit risk varies with the degree of energy efficiency.
Energy efficiency represents one of the key planned actions aiming at reducing greenhouse emissions and the consumption of fossil fuel to mitigate the impact of climate change. In this paper, we investigate the relationship between energy efficiency and the borrower’s solvency risk in the Italian market. Specifically, we analyze a residential mortgage portfolio of four financial institutions which includes about 70,000 loans matched with the energy performance certificate of the associated buildings. Our findings show that there is a negative relationship between a building’s energy efficiency and the owner’s probability of default. Findings survive after we account for dwelling, household, mortgage, market control variables, and regional and year fixed effect. Additionally, a ROC analysis shows that there is an improvement in the estimation of the mortgage default probability when the energy efficiency characteristic is included as a risk predictor in the model.
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.
In this study, we unpack the ESG ratings of four prominent agencies in Europe and find that (i) each single E, S, G pillar explains the overall ESG score differently,(ii) there is a low co-movement between the three E, S, G pillars and (iii) there are specific ESG Key Performance Indicators (KPIs) that are driving these ratings more than others. We argue that such discrepancies might mislead firms about their actual ESG status, potentially leading to cherry-picking areas for improvement, thus raising questions about the accuracy and effectiveness of ESG evaluations in both explaining sustainability and driving capital toward sustainable companies.
We delve into the EU's regulatory changes aimed at boosting transparency in sustainable investments. By examining disparities among ESG rating agencies, we assess how these differences challenge standardization and consensus. Our analysis underscores the critical need for clearer ESG assessments to guide the sustainable investment landscape.
The centrality of the United States in the global financial system is taken for granted, but its response to recent political and epidemiological events has suggested that China now holds a comparable position. Using minute-by-minute data from 2012 to 2020 on the financial performance of twelve country-specific exchange-traded funds, we construct daily snapshots of the global financial network and analyze them for the centrality and connectedness of each country in our sample. We find evidence that the U.S. was central to the global financial system into 2018, but that the U.S.-China trade war of 2018–2019 diminished its centrality, and the Covid-19 outbreak of 2019–2020 increased the centrality of China. These indicators may be the first signals that the global financial system is moving from a unipolar to a bipolar world.
In the aftermath of the global financial crisis, both resolution planning, i.e. contingency planning by both regulated institutions and public authorities in order to prepare their actions in financial crisis, and concepts for structural bank reform have been identified as possible solutions to ending “Too Big To Fail” and foster market discipline among bank owners, bank managers and investors in bank debt. Both concepts thus complement the global quest for reliable procedures and tools for bank resolution that would minimise systemic implications once large and complex financial institutions have reached the stage of insolvency. Given the complex task of orchestrating swift and effective resolution actions, especially with regard to cross-border banking groups and financial conglomerates, planning ahead in good times has since been widely recognised as crucial for enhancing resolvability. At least part of the impediments to resolution will be found in organisational, financial and legal complexity that has evolved in banks and groups over time. To remove these impediments, interference with existing corporate and group structures is all but inevitable. However, in both international standard setting and at the European Union level, issues related to resolution planning (within the context of bank resolution reform) and structural banking reforms to date have been discussed rather separately. This lack of consistency is questionable, given the obvious need to reconcile both approaches in order to facilitate effective implementation and enforcement especially with regard to large, complex banking groups. Based on an analysis both of the Bank Recovery and Resolution Directive and the SRM Regulation, this paper explores how these problems could be dealt with within the context of the European Banking Union.
The creation of the Banking Union is likely to come with substantial implications for the governance of Eurozone banks. The European Central Bank, in its capacity as supervisory authority for systemically important banks, as well as the Single Resolution Board, under the EU Regulations establishing the Single Supervisory Mechanism and the Single Resolution Mechanism, have been provided with a broad mandate and corresponding powers that allow for far-reaching interference with the relevant institutions’ organisational and business decisions. Starting with an overview of the relevant powers, the present paper explores how these could – and should – be exercised against the backdrop of the fundamental policy objectives of the Banking Union. The relevant aspects directly relate to a fundamental question associated with the reallocation of the supervisory landscape, namely: Will the centralisation of supervisory powers, over time, also lead to the streamlining of business models, corporate and group structures of banks across the Eurozone?
Panel Sample Selection ModelsThe empirical evidence currently available in the literature regarding the effects of a country's IMF program participation on its output growth is rather inconclusive. In this paper we propose and estimate a panel data sample selection model featuring state dependence. As in this model the output growth effects of program participation can be conditional on the realization of a state variable (conditional pooling), our framework may reconcile previous empirical evidence based on models without state-dependent effects. We find that the effects of IMF program participation on output growth vary systematically with an index reflecting a country's institutional record, and that output growth effects of program participation are significantly positive only if the program participation is coupled with sufficient improvement of the institutional record.
For some time now, structural macroeconomic models used at central banks have been predominantly New Keynesian DSGE models featuring nominal rigidities and forwardlooking decision-making. While these features are widely deemed crucial for policy evaluation exercises, most central banks have added more detailed characterizations of the financial sector to these models following the Great Recession in order to improve their fit to the data and their forecasting performance. We employ a comparative approach to investigate the characteristics of this new generation of New Keynesian DSGE models and document an elevated degree of model uncertainty relative to earlier model generations. Policy transmission is highly heterogeneous across types of financial frictions and monetary policy causes larger effects, on average. The New Keynesian DSGE models we analyze suggest that a simple policy rule robust to model uncertainty involves a weaker response to inflation and the output gap in the presence of financial frictions as compared to earlier generations of such models. Leaning-against-the-wind policies in models of this class estimated for the Euro Area do not lead to substantial gains. With regard to forecasting performance, the inclusion of financial frictions can generate improvements, if conditioned on appropriate data. Looking forward, we argue that model-averaging and embracing alternative modelling paradigms is likely to yield a more robust framework for the conduct of monetary policy.
In this paper we revisit medium- to long-run exchange rate determination, focusing on the role of international investment positions. To do so, we develop a new econometric framework accounting for conditional long-run homogeneity in heterogeneous dynamic panel data models. In particular, in our model the long-run relationship between effective exchange rates and domestic as well as weighted foreign prices is a homogeneous function of a country’s international investment position. We find rather strong support for purchasing power parity in environments of limited negative net foreign asset to GDP positions, but not outside such environments. We thus argue that the purchasing power parity hypothesis holds conditionally, but not unconditionally, and that international investment positions are an essential component to characterizing this conditionality. Finally, we adduce evidence that whether deterioration of a country’s net foreign asset to GDP position leads to a depreciation of that country’s effective exchange rate depends on its rate of inflation relative to the rate of inflation abroad as well as its exposure to global shocks. JEL Classification: F31, F37, C23
The European Central Bank
(2007)
The establishment of the ECB and with it the launch of the euro has arguably been a unique endeavor in economic history, representing an important experiment in central banking. This note aims to summarize some of the main lessons learned from this experiment and sketch some of the prospects for the ECB. It is written for "The New Palgrave Dictionary of Economics", 2nd edition. JEL Classification: E52, E58
RECENTLY, A NEW CLASS OF SYSTEMS FOR SHARED AND COLLABORATIVE DATA MANAGEMENT HAS GAINED MORE AND MORE TRACTION. IN CONTRAST TO CLASSICAL DATA BASE MANAGEMENT SYSTEMS (DBMS), SYSTEMS FOR SHARED DATA NEED TO PROVIDE ADDITIONAL GUARANTEES TO ENSURE THE INTEGRITY OF DATA AND TRANSACTION EXECUTION. IN THIS PAPER, WE PRESENT TRUSTDBLE, A NEW DBMS THAT EXTENDS THE ACID PROPERTIES (I.E., ATOMICITY, CONSISTENCY, ISOLATION, DURABILITY) USED BY CLASSICAL DBMSS WITH A NEW VERIFIABILITY COMPONENT TO ADDRESS THESE NEW REQUIREMENTS.
The loan impairment rules recently introduced by IFRS 9 require banks to estimate their future credit losses by using forward-looking information. We use supervisory loan-level data from Germany to investigate how banks apply their reporting discretion and adjust their lending upon the announcement of the new rules. Our identification strategy exploits a cut-off for the level of provisions at the investment grade threshold based on banks’ internal rating of a borrower. We find that banks required to adopt the new rules assign better internal ratings to exactly the same borrowers compared to banks that do not apply IFRS 9 around this cut-off. This pattern is consistent with a strategic use of the increased reporting discretion that is inherent to rules requiring forward-looking loss estimation. At the same time, banks also reduce their lending exposure to exactly those borrowers at the highest risk of experiencing a rating downgrade below the cutoff. These loans would be associated with additional provisions in future periods, both in the intensive and extensive margin. The lending change thus mitigates some of the negative effects of increased reporting opportunism on banks’ crisis resilience. However, when these firms with internal ratings around the investment grade cut-off obtain less external funding through banks, the introduction of IFRS 9 will likely also be associated with real economic effects
European banks have substantial investments in assets that are
measured without directly observable market prices (mark-to-
model). Financial disclosures of these value estimates lack
standardization and are hard to compare across banks. These
comparability concerns are concentrated in large European
banks that extensively rely on level 3 estimates with the most
unobservable inputs. Although the relevant balance sheet
positions only represent a small fraction of these large banks’
total assets (2.9%), their value equals a significant fraction of core
equity tier 1 (48.9%). Incorrect valuations thus have a potential to
impact financial stability. 85% of these bank assets are under
direct ECB supervision. Prudential regulation requires value
adjustments that are apt to shield capital against valuation risk.
Yet, stringent enforcement is critical for achieving this objective.
This document was provided by the Economic Governance
Support Unit at the request of the ECON Committee.
Accounting for financial stability: Bank disclosure and loss recognition in the financial crisis
(2020)
This paper examines banks’ disclosures and loss recognition in the financial crisis and identifies several core issues for the link between accounting and financial stability. Our analysis suggests that, going into the financial crisis, banks’ disclosures about relevant risk exposures were relatively sparse. Such disclosures came later after major concerns about banks’ exposures had arisen in markets. Similarly, the recognition of loan losses was relatively slow and delayed relative to prevailing market expectations. Among the possible explanations for this evidence, our analysis suggests that banks’ reporting incentives played a key role, which has important implications for bank supervision and the new expected loss model for loan accounting. We also provide evidence that shielding regulatory capital from accounting losses through prudential filters can dampen banks’ incentives for corrective actions. Overall, our analysis reveals several important challenges if accounting and financial reporting are to contribute to financial stability.
This paper investigates what we can learn from the financial crisis about the link between accounting and financial stability. The picture that emerges ten years after the crisis is substantially different from the picture that dominated the accounting debate during and shortly after the crisis. Widespread claims about the role of fair-value (or mark-to-market) accounting in the crisis have been debunked. However, we identify several other core issues for the link between accounting and financial stability. Our analysis suggests that, going into the financial crisis, banks’ disclosures about relevant risk exposures were relatively sparse. Such disclosures came later after major concerns about banks’ exposures had arisen in markets. Similarly, banks delayed the recognition of loan losses. Banks’ incentives seem to drive this evidence, suggesting that reporting discretion and enforcement deserve careful consideration. In addition, bank regulation through its interlinkage with financial accounting may have dampened banks’ incentives for corrective actions. Our analysis illustrates that a number of serious challenges remain if accounting and financial reporting are to contribute to financial stability.
In the aftermath of an increasing integration of property and financial markets, the real estate industry is subject to soaring internationalization processes. Since international institutional investors appeared, transnational real estate investments have increased tremendously. In recent years, Central and Eastern European countries have been becoming more attractive to institutional investors and are therefore being integrated into international market structures. Within these countries, Warsaw emerged as the most dynamic and important real estate market. But what are the mechanisms and practices through which the real estate market of Warsaw becomes international? Which networks, intermediaries and frames are necessary to constitute a mature real estate market? The article argues that international real estate consultants are playing a crucial role in the underlying internationalization process. They are acting at the interface between investors, developers, construction companies and tenants and are therefore becoming a crucial hinge between real estate actors. With the example of the Warsaw real estate market we argue that international real estate consultancies are key drivers of the transformation process from a local to a global market. They transfer global knowledge, competence and practices and implement transparent and professional structures in the emerging Warsaw real estate market.
We develop a utility based model of fluctuations, with nominal rigidities, and unemployment. In doing so, we combine two strands of research: the New Keynesian model with its focus on nominal rigidities, and the Diamond-Mortensen-Pissarides model, with its focus on labor market frictions and unemployment. In developing this model, we proceed in two steps. We first leave nominal rigidities aside. We show that, under a standard utility specification, productivity shocks have no effect on unemployment in the constrained efficient allocation. We then focus on the implications of alternative real wage setting mechanisms for fluctuations in unemployment. We then introduce nominal rigidities in the form of staggered price setting by firms. We derive the relation between inflation and unemployment and discuss how it is influenced by the presence of real wage rigidities. We show the nature of the tradeoff between inflation and unemployment stabilization, and we draw the implications for optimal monetary policy. JEL Classification: E32, E50
BANK INSTABILITY SEEMINGLY COULD PUSH BORROWERS TO USE CROWDFUNDING AS A SOURCE OF EXTERNAL FINANCE. WE CONSTRUCT A NOVEL, HAND-COLLECTED DATA SET OF VENTURES' USES OF EQUITY CROWDFUNDING IN GERMANY, THEIR RELATIONSHIPS WITH BANKS, AND VARIOUS VENTURE TRAITS SINCE 2011. BY OBSERVING VENTUREBANK RELATIONSHIPS, WE CAN IDENTIFY IF VENTURES CONNECTED TO SHOCKED BANKS ARE MORE LIKELY TO USE CROWDFUNDING IN AN ATTEMPT TO SUBSTITUTE FOR CONTRACTING BANK CREDIT SUPPLY. OUR RESULTS SHOW THAT CROWDFUNDING IS SIGNIFICANTLY MORE LIKELY FOR NEW VENTURES THAT INTERACT WITH STRESSED BANKS. INNOVATIVE FUNDING SOURCES ARE THUS PARTICULARLY RELEVANT IN TIMES OF STRESS AMONG CONVENTIONAL FINANCIERS. BUT CROWDFUNDED VENTURES ARE GENERALLY ALSO MORE OPAQUE AND RISKY THAN NEW VENTURES THAT DO NOT USE CROWDFUNDING.
UNDER LAISSEZ-FAIRE REGULATION, REGULATORS CHOOSE NOT TO INTERFERE BECAUSE THEY SEEK TO STIMULATE INNOVATION AND PROTECT ENTERPRISES FROM THE COSTS IMPOSED BY REGULATORY COMPLIANCE. YET, EMPIRICAL EVIDENCE REGARDING THE ABILITY OF LAISSEZ-FAIRE REGULATION TO ENSURE CONSUMER PROTECTION IS LACKING. THIS ARTICLE TESTS EMPIRICALLY WHETHER THE CURRENT LAISSEZ-FAIRE REGULATION OF PRICE ADVERTISING CLAIMS ON THE MOST POPULAR REWARD-BASED CROWDFUNDING PLATFORM, KICKSTARTER, IS SUFFICIENT TO PROTECT CONSUMERS.
ENTREPRENEURS OFTEN OVERESTIMATE THE LIKELIHOOD OF SUCCESS WHEN PLANNING THEIR OWN ACTIVITIES, WHICH USUALLY RESULTS IN EXCESS MARKET ENTRY. SINCE ENTREPRENEURS CONSIDER THEIR PROJECT AS UNIQUE, THE FORECASTS OF THE FUTURE OUTCOME ARE OFTEN ANCHORED ON THE CASE AT HAND RATHER THAN ON PAST RESULTS OF COMPARABLE PROJECTS – A PHENOMENON KNOWN AS THE PLANNING FALLACY. WE INVESTIGATE WHETHER ENTREPRENEURS SUFFER FROM A PLANNING FALLACY BIAS WHEN PROVIDED WITH HISTORICAL OUTCOMES OF COMPARABLE PROJECTS AND ITS CONSEQUENCES.
The purpose of the data presented in this article is to use it in ex post estimations of interest rate decisions by the European Central Bank (ECB), as it is done by Bletzinger and Wieland (2017) [1]. The data is of quarterly frequency from 1999 Q1 until 2013 Q2 and consists of the ECB's policy rate, inflation rate, real output growth and potential output growth in the euro area. To account for forward-looking decision making in the interest rate rule, the data consists of expectations about future inflation and output dynamics. While potential output is constructed based on data from the European Commission's annual macro-economic database, inflation and real output growth are taken from two different sources both provided by the ECB: the Survey of Professional Forecasters and projections made by ECB staff. Careful attention was given to the publication date of the collected data to ensure a real-time dataset only consisting of information which was available to the decision makers at the time of the decision.
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.
On July 4, 2013 the ECB Governing Council provided more specific forward guidance than in the past by stating that it expects ECB interest rates to remain at present or lower levels for an extended period of time. As explained by ECB President Mario Draghi this expectation is based on the Council’s medium-term outlook for inflation conditional on economic activity and money and credit. Draghi also stressed that there is no precise deadline for this extended period of time, but that a reasonable period can be estimated by extracting a reaction function. In this note, we use such a reaction function, namely the interest rate rule from Orphanides and Wieland (2013) that matches past ECB interest rate decisions quite well, to project the rate path consistent with inflation and growth forecasts from the survey of professional forecasters published by the ECB on August 8, 2013. This evaluation suggests an increase in ECB interest rates by May 2014 at the latest. We also use the Eurosystem staff projection from June 6, 2013 for comparison. While it would imply a longer period of low rates, it does not match past ECB decisions as well as the reaction function with SPF forecasts.
In this paper, we investigate how bank mergers affect bank revenues and present empirical evidence that mergers among banks have a substantial and persistent negative impact on merging banks’ revenues. We refer to merger related negative effects on banks’ revenues as dissynergies and suggest that they are a result of organizational diseconomies, the loss of customers and the temporary distraction of management from day-to-day operations by effecting the merger. For our analyses we draw on a proprietary data set with detailed financials of all 457 regional savings banks in Germany, which have been involved in 212 mergers between 1994 and 2006. We find that the negative impact of a merger on net operating revenues amounts to 3% of pro-forma consolidated banks’ operating profits and persists not only for the year of the merger but for up to four years post-merger. Only thereafter mergers exhibit a significantly superior performance compared to their respective pre-merger performance or the performance of their non-merging peers. The magnitude and persistence of merger related revenue dissynergies highlight their economic relevance. Previous research on post-merger performance mainly focuses on the effects from mergers on banks’ (cost) efficiency and profitability but fails to provide clear and consistent results. We are the first, to our knowledge, to examine the post-merger performance of banks’ net operating revenues and to empirically verify significant negative implications of mergers for banks’ net operating revenues. We propose that our finding of negative merger related effects on banks’ operating revenues is the reason why previous research fails to show merger related gains.
In this paper, we examine the impact of mergers among German savings banks on the extent to which these savings banks engage in small business lending. The ongoing consolidation in the banking industry has sparked concerns about the continuous availability of credit to small businesses which has been further fueled by empirical studies that partly confirm a reduction in small business lending in the aftermath of mergers. However, using a proprietary data set of German savings banks we find strong evidence that in Germany merging savings banks do not significantly change the extent to which they lend to small businesses compared to prior to the merger or compared to the contemporaneous lending by non-merging banks. We investigate the merger related effects on small business lending in Germany from a bank-level perspective. Furthermore, we estimate small business lending and its continuous adjustment process simultaneously using recent General Method of Moments (GMM) techniques for panel data as proposed by Arellano and Bond (1991).
ALMOST 20% OF THE GERMAN POPULATION CURRENTLY HOLDS A CONSUMER LOAN. DESPITE ITS OBVIOUS IMPORTANCE FOR A PRIVATE HOUSEHOLD’S BALANCE SHEET, WE KNOW SURPRISINGLY LITTLE ABOUT IT. ONE PURPOSE OF THIS STUDY IS TO GIVE AN OVERVIEW OF THE GERMAN CONSUMER/INSTALLMENT LOAN MARKET. WE COMPARED FIVE WIDELY ACCEPTED DATA SOURCES AND FOUND DIFFERENCES IN THE LOAN PARTICIPATION RATE, EVEN ON AN AGGREGATED NATIONWIDE LEVEL. IN A SECOND STEP, WE TRY TO FIND REASONS FOR EXTRAORDINARY HIGH GROWTH RATES AMONG SENIORS’ DEBT PARTICIPATION RATES.
In a unifying framework generalizing established theories we characterize under which conditions Joint Ownership of assets creates the best cooperation incentives in a partnership. We endogenise renegotiation costs and assume that they weakly increase with additional assets. A salient sufficient condition for optimal cooperation incentives among patient partners is if Joint Ownership is a Strict Coasian Institution for which transaction costs impede an efficient asset reallocation after a breakdown. In contrast to Halonen (2002) the logic behind our results is that Joint Ownership maximizes the value of the relationship and the costs of renegotiating ownership after a broken relationship.
This paper provides an overview of how to use "big data" for economic research. We investigate the performance and ease of use of different Spark applications running on a distributed file system to enable the handling and analysis of data sets which were previously not usable due to their size. More specifically, we explain how to use Spark to (i) explore big data sets which exceed retail grade computers memory size and (ii) run typical econometric tasks including microeconometric, panel data and time series regression models which are prohibitively expensive to evaluate on stand-alone machines. By bridging the gap between the abstract concept of Spark and ready-to-use examples which can easily be altered to suite the researchers need, we provide economists and social scientists more generally with the theory and practice to handle the ever growing datasets available. The ease of reproducing the examples in this paper makes this guide a useful reference for researchers with a limited background in data handling and distributed computing.
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 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.
The interbank market is important for the efficient functioning of the financial system, transmission of monetary policy and therefore ultimately the real economy. In particular, it facilitates banks' liquidity management. This paper aims at extending the literature which views interbank markets as mutual liquidity insurance mechanism by taking into account persistence of liquidity shocks. Following a theory of long-term interbank funding a financial system which is modeled as a micro-founded agent based complex network interacting with a real economic sector is developed. The model features interbank funding as an over-the-counter phenomenon and realistically replicates financial system phenomena of network formation, monetary policy transmission and endogenous money creation. The framework is used to carry out an optimal policy analysis in which the policymaker maximizes real activity via choosing the optimal interest rate in a trade-off between loan supply and financial fragility. It is shown that the interbank market renders the financial system more efficient relative to a setting without mutual insurance against persistent liquidity shocks and therefore plays a crucial role for welfare.
We develop a dynamic network model with heterogenous banks which undertake optimizing portfolio decisions subject to liquidity and capital constraints and trade in the interbank market whose equilibrium is governed by a tatonnement process. Due to the micro-funded structure of the decisional process as well as the iterative dynamic adjustment taking place in the market, the links in the network structures are endogenous and evolve dynamically. We use the model to assess the diffusion of systemic risk (measured as default probability), the contribution of each bank to it as well as the evolution of the network in response to financial shocks and across different prudential policy regimes.
We develop a dynamic network model with heterogenous banks which undertake optimizing portfolio decisions subject to liquidity and capital constraints and trade in the interbank market whose equilibrium is governed by a tatonnement process. Due to the micro-funded structure of the decisional process as well as the iterative dynamic adjustment taking place in the market, the links in the network structures are endogenous and evolve dynamically. We use the model to assess the diffusion of systemic risk, the contribution of each bank to it as well as the evolution of the network in response to financial shocks and across different prudential policy regimes.
We develop a dynamic network model whose links are governed by banks' optmizing decisions and by an endogenous tâtonnement market adjustment. Banks in our model can default and engage in firesales: risk is transmitted through direct and cascading counterparty defaults as well as through indirect pecuniary externalities triggered by firesales. We use the model to assess the evolution of the network configuration under various prudential policy regimes, to measure banks' contribution to systemic risk (through Shapley values) in response to shocks and to analyze the effects of systemic risk charges. We complement the analysis by introducing the possibility of central bank liquidity provision.
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 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
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.
Derivatives usage in risk management by U.S. and German non-financial firms : a comparative survey
(1998)
This paper is a comparative study of the responses to the 1995 Wharton School survey of derivative usage among US non-financial firms and a 1997 companion survey on German non-financial firms. It is not a mere comparison of the results of both studies but a comparative study, drawing a comparable subsample of firms from the US study to match the sample of German firms on both size and industry composition. We find that German firms are more likely to use derivatives than US firms, with 78% of German firms using derivatives compared to 57% of US firms. Aside from this higher overall usage, the general pattern of usage across industry and size groupings is comparable across the two countries. In both countries, foreign currency derivative usage is most common, followed closely by interest rate derivatives, with commodity derivatives a distant third. Usage rates across all three classes of derivatives are higher for German firms than US firms. In contrast to the similarities, firms in the two countries differ notably on issues such as the primary goal of hedging, their choice of instruments, and the influence of their market view when taking derivative positions. These differences appear to be driven by the greater importance of financial accounting statements in Germany than the US and stricter German corporate policies of control over derivative activities within the firm. German firms also indicate significantly less concern about derivative related issues than US firms, which appears to arise from a more basic and simple strategy for using derivatives. Finally, among the derivative non-users, German firms tend to cite reasons suggesting derivatives were not needed whereas US firms tend to cite reasons suggesting a possible role for derivatives, but a hesitation to use them for some reason.
We introduce a copula-based dynamic model for multivariate processes of (non-negative) high-frequency trading variables revealing time-varying conditional variances and correlations. Modeling the variables’ conditional mean processes using a multiplicative error model we map the resulting residuals into a Gaussian domain using a Gaussian copula. Based on high-frequency volatility, cumulative trading volumes, trade counts and market depth of various stocks traded at the NYSE, we show that the proposed copula-based transformation is supported by the data and allows capturing (multivariate) dynamics in higher order moments. The latter are modeled using a DCC-GARCH specification. We suggest estimating the model by composite maximum likelihood which is sufficiently flexible to be applicable in high dimensions. Strong empirical evidence for time-varying conditional (co-)variances in trading processes supports the usefulness of the approach. Taking these higher-order dynamics explicitly into account significantly improves the goodness-of-fit of the multiplicative error model and allows capturing time-varying liquidity risks.
I analyze the most powerful shareholders in Germany to illustrate the concentration of control over listed corporations. Compared to other developed economies, the German stock market is dominated by large shareholders. I show that 77% of the median firm’s voting rights arecontrolled by large blockholders. This corresponds to 47% of the market value of all firms listed in Germany’s official markets. About two thirds of this amount is controlled by banks, industrial firms, holdings, and insurance companies. I show that due to current legislation it is clear for neither group who ultimate exerts control over the shareholding firm itself. For the remaining blockholders, only blocks controlled by voting pools and individuals can be traced back to the highest level of ownership. In the aggregate, both groups control only 5.6% of all reported blocks. The German government controls 8%, and it is not clear who ultimately is responsible for the consequences of decisions.
Using a unique data set on trade credit defaults among French firms, we investigate whether and how trade credit is used to relax financial constraints. We show that firms that face idiosyncratic liquidity shocks are more likely to default on trade credit, especially when the shocks are unexpected, firms have little liquidity, are likely to be credit constrained or are close to their debt capacity. We estimate that credit constrained firms pass more than one fourth of the liquidity shocks they face on to their suppliers down the trade credit chain. The evidence is consistent with the idea that firms provide liquidity insurance to each other and that this mechanism is able to alleviate the consequences of credit constraints. In addition, we show that the chain of defaults stops when it reaches firms that are large, liquid, and have access to financial markets. This suggests that liquidity is allocated from large firms with access to outside finance to small, credit constrained firms through trade credit chains.
This paper uses factor-augmented vector autoregressions (FAVAR) estimated using a large data set to disentangle fluctuations in disaggregated consumer and producer prices which are due to macroeconomic factors from those due to sectorial conditions. This allows us to provide consistent estimates of the effects of US monetary policy on disaggregated prices. While sectorial prices respond quickly to sector-specific shocks, we find that for a large number of price series, there is a significant delay in the response of prices to monetary policy shocks. In addition, price responses display little evidence of a “price puzzle,” contrary to existing studies based on traditional VARs. The observed dispersion in the reaction of producer prices is relatively well explained by the degree of market power, as predicted by models with monopolistic competition. JEL Classification: E32, E52
The recent wave of randomized trials in development economics has provoked criticisms regarding external validity. We investigate two concerns—heterogeneity across beneficiaries and implementers—in a randomized trial of contract teachers in Kenyan schools. The intervention, previously shown to raise test scores in NGO- led trials in Western Kenya and parts of India, was replicated across all Kenyan provinces by an NGO and the government. Strong effects of shortterm contracts produced in controlled experimental settings are lost in weak public institutions: NGO implementation produces a positive effect on test scores across diverse contexts, while government implementation yields zero effect. The data suggests that the stark contrast in success between the government and NGO arm can be traced back to implementation constraints and political economy forces put in motion as the program went to scale.
A large empirical literature has shown that user fees signicantly deter public service utilization in developing #countries. While most of these results reflect partial equilibrium analysis, we find that the nationwide abolition of public school fees in Kenya in 2003 led to no increase in net public enrollment rates, but rather a dramatic shift toward private schooling. Results suggest this divergence between partial- and general-equilibrium effects is partially explained by social interactions: the entry of poorer pupils into free education contributed to the exit of their more affluent peers.
Existing studies from the United States, Latin America, and Asia provide scant evidence that private schools dramatically improve academic performance relative to public schools. Using data from Kenya—a poor country with weak public institutions—we find a large effect of private schooling on test scores, equivalent to one full standard deviation. This finding is robust to endogenous sorting of more able pupils into private schools. The magnitude of the effect dwarfs the impact of any rigorously tested intervention to raise performance within public schools. Furthermore, nearly twothirds of private schools operate at lower cost than the median government school.
Causality is a widely-used concept in theoretical and empirical economics. The recent financial economics literature has used Granger causality to detect the presence of contemporaneous links between financial institutions and, in turn, to obtain a network structure. Subsequent studies combined the estimated networks with traditional pricing or risk measurement models to improve their fit to empirical data. In this paper, we provide two contributions: we show how to use a linear factor model as a device for estimating a combination of several networks that monitor the links across variables from different viewpoints; and we demonstrate that Granger causality should be combined with quantile-based causality when the focus is on risk propagation. The empirical evidence supports the latter claim.
The Asian financial crisis of 1997-98 was one of the most dramatic economic events of recent times, which raised many questions regarding the appropriate policy response to financial crises. This paper reviews the experience of this crisis, focusing on the overall strategy of crisis management and the way that strategy was implemented including, with regard to official and private financing, structural reforms, and monetary and fiscal policies.
The spreading of the Covid-19 virus causes a reduction in economic activity worldwide and may lead to new risks to financial stability. The authors draw attention to the urgency of the targeted mitigation strategies on the European level and suggest taking coordinated action on the fiscal side to provide liquidity to affected firms in the corporate sector. Otherwise, virus-related cashflow interruptions could lead to a new full-blown banking crisis. Monetary policy measures are unlikely to mitigate cash liquidity shortages at the level of individual firms. Coordinated action at European level is decisive to prevent markets from losing confidence in the resilience of banks, particularly in countries with limited fiscal capacity. In contrast to the euro crisis of 2011, the cause of the current crisis does not lie in the financial markets; therefore, the risk of moral hazard for banks or states is low.
This Policy Letter presents a proposal for designing a program of government assistance for firms hurt by the Coronavirus crisis in the European Union (EU). In our recent Policy Letter 81, we introduced a new, equity-type instrument, a cash-against-tax surcharge scheme, bundled across firms and countries in a European Pandemic Equity Fund (EPEF). The present Policy Letter 84 focuses on the principles and conditions relevant for the operationalization of a EPEF. Our proposal has several desirable features. It: a) offers better risk sharing opportunities, augmenting the resilience of businesses and EU economies; b) is need-based, thereby contributing to an effective use of resources; c) builds on conditions and credible controls, addressing adverse selection and moral hazard; d) is accessible to smaller and medium-sized firms, the backbone of Europe’s economy; e) applies Europe-wide uniform eligibility criteria, strengthening support among member states; f) is a scheme of limited duration, reducing (perceived) government interference in businesses; g) creates a template for a growth-oriented public policy, aligning public and private sector interests; and h) builds on the existing institutional infrastructure and requires minimal legislative adjustments.
This policy letter adds to the current discussion on how to design a program of government assistance for firms hurt by the Coronavirus crisis. While not pretending to provide a cure-all proposal, the advocated scheme could help to bring funding to firms, even small firms, quickly, without increasing their leverage and default risk. The plan combines outright cash transfers to firms with a temporary, elevated corporate profit tax at the firm level as a form of conditional payback. The implied equity-like payment structure has positive risk-sharing features for firms, without impinging on ownership structures. The proposal has to be implemented at the pan-European level to strengthen Euro area resilience.
With the second wave of the Covid-19 pandemic in full swing, banks face a challenging environment. They will need to address disappointing results and adverse balance sheet restatements, the intensity of which depends on the evolution of the euro area economies. At the same time, vulnerable banks reinforce real economy deficiencies. The contribution of this paper is to provide a comparative assessment of the various policy responses to address a looming banking crisis. Such a crisis will fully materialize when non-performing assets drag down banks simultaneously, raising the specter of a full-blown systemic crisis. The policy responses available range from forbearance, recapitalization (with public or private resources), asset separation (bad banks, at national or EU level), to debt conversion schemes. We evaluate these responses according to a set of five criteria that define the efficacy of each. These responses are not mutually exclusive, in practice, as they have never been. They may also go hand in hand with other restructuring initiatives, including potential consolidation in the banking sector. Although we do not make a specific recommendation, we provide a framework for policymakers to guide them in their decision making.
In this paper, we examine three famous episodes of deliberate deflation (or disinflation) in U.S. history, including episodes following the Civil War, World War I, and the Volcker disinflation of the early 1980s. These episodes were associated with widely divergent effects on the real economy, which we attribute both to differences in the policy actions undertaken, and to the transparency and credibility of the monetary authorities. We attempt to account for the salient features of each episode within the context of a stylized DSGE model. Our model simulations indicate how a more predictable policy of gradual deflation could have helped avoid the sharp post-WWI depression. But our analysis also suggests that the strong argument for gradualism under a transparent monetary regime becomes less persuasive if the monetary authority lacks credibility; in this case, an aggressive policy stance (as under Volcker) can play a useful signalling role by making a policy shift more apparent to private agents. JEL Classification: E31, E32, E52
Does austerity pay off?
(2014)
Policy makers often implement austerity measures when the sustainability of public finances is in doubt and, hence, sovereign yield spreads are high. Is austerity successful in bringing about a reduction in yield spreads? We employ a new panel data set which contains sovereign yield spreads for 31 emerging and advanced economies and estimate the effects of cuts of government consumption on yield spreads and economic activity. The conditions under which austerity takes place are crucial. During times of fiscal stress, spreads rise in response to the spending cuts, at least in the short-run. In contrast, austerity pays off, if conditions are more benign.
From its early post-war catch-up phase, Germany’s formidable export engine has been its consistent driver of growth. But Germany has almost equally consistently run current account surpluses. Exports have powered the dynamic phases and helped emerge from stagnation. Volatile external demand, in turn, has elevated German GDP growth volatility by advanced countries’ standards, keeping domestic consumption growth at surprisingly low levels. As a consequence, despite the size of its economy and important labor market reforms, Germany’s ability to act as global locomotive has been limited. With increasing competition in its traditional areas of manufacturing, a more domestically-driven growth dynamic, especially in the production and delivery of services, will be good for Germany and for the global economy. Absent such an effort, German growth will remain constrained, and Germany will play only a modest role in spurring growth elsewhere.
Emotions-at-risk: an experimental investigation into emotions, option prices and risk perception
(2014)
This paper experimentally investigates how emotions are associated with option prices and risk perception. Using a binary lottery, we find evidence that the emotion ‘surprise’ plays a significant role in the negative correlation between lottery returns and estimates of the price of a put option. Our findings shed new light on various existing theories on emotions and affect. We find gratitude, admiration, and joy to be positively associated with risk perception, although the affect heuristic predicts a negative association. In contrast with the predictions of the appraisal tendency framework (ATF), we document a negative correlation between option price and surprise for lottery winners. Finally, the results show that the option price is not associated with risk perception as commonly used in psychology.
We investigate the effect of the tone of news on investor stock price expectations and beliefs. In an experimental study we ask subjects to estimate a future stock price for twelve real listed companies. As additional information we provide them with historical stock prices and extracts from real newspaper articles. We propose a way to manipulate the tone of news extracts without distorting its content. Subjects in different treatment groups read news items that are written either in positive or negative tone for each stock. We find that subjects tend to predict a significantly higher (lower) return for stocks after reading positive (negative) tone news. The effect is especially pronounced for stocks with poor past performance. Subjects are more likely to be optimistic (pessimistic) about the economy and to buy (sell) stocks after reading positive (negative) than negative (positive) tone news. Our results show that the news media might affect not only how investors perceive information, but also what they do in response to it.
We test whether asymmetric preferences for losses versus gains as in Ang, Chen, and Xing (2006) also affect the pricing of cash flow versus discount rate news as in Campbell and Vuolteenaho (2004). We construct a new four-fold beta decomposition, distinguishing cash flow and discount rate betas in up and down markets. Using CRSP data over 1963–2008, we find that the downside cash flow beta and downside discount rate beta carry the largest premia. We subject our result to an extensive number of robustness checks. Overall, downside cash flow risk is priced most consistently across different samples, periods, and return decomposition methods, and is the only component of beta that has significant out-of-sample predictive ability. The downside cash flow risk premium is mainly attributable to small stocks. The risk premium for large stocks appears much more driven by a compensation for symmetric, cash flow related risk. Finally, we multiply our premia estimates by average betas to compute the contribution of the different risk components to realized average returns. We find that up and down discount rate components dominate the contribution to average returns of downside cash flow risk. Keywords: Asset Pricing, Beta, Downside Risk, Upside Risk, Cash Flow Risk, Discount Rate Risk JEL Classification: G11, G12, G14
The current discussion about a “risk culture” in financial services was triggered by the recent series of financial crises. The last decade saw a long list of hubris, misconduct and criminal activities by human beings on a single or even a collective basis in banks, in the industry or in the whole economy. As a counter-reaction, financial authorities called for a guidance by a “new” risk culture in financial institutions based on a set of abstract, formal, and normative governance processes. While traditional risk research in economics and in banking was focused on the statistical aspects of risk as the probability of loss multiplied by the amount of loss, culture is a paraphrase for the behavior in collectives and dynamics of organization found in human societies. Therefore, a “risk culture” should link the normative concepts of risk with the positive “real-world” decision-making in financial services. This paper will describe a novel view on “risk culture” from the perspective of human beings interacting in dynamical and intertemporal commercial relations. In this context “risk” is perceived by economic agents ex−ante as the consequence of the time lag between the present and the uncertain future development (compared to a probability distribution calculated by observers ex−post). For all those individual decisions—to be made under uncertainty—future “risk” includes the so-called “normal accidents”, i.e., failures that will happen at some uncertain point in time but are inevitable, and the only questions are when failure will happen and how to maintain function in the first line of defense. Finally, the shift from an abstract definition of “risk” as a probability distribution to a role model of “honorable merchants” as a benchmark for significant individual decision-making with individual responsibilities for the uncertain future outcome provides a new framework to discuss the responsibilities in the financial industry.
We estimate the effect of pension reforms on households' expectations of retirement outcomes and private wealth accumulation decisions exploiting a decade of intense Italian pension reforms as a source of exogenous variation in expected pension wealth. The Survey of Household Income and Wealth, a large random sample of the Italian population, elicits expectations of the age at which workers expect to retire and of the ratio of pension benefits to pre-retirement income between 1989 and 2002. We find that workers have revised expectations in the direction suggested by the reform and that there is substantial offset between private wealth and perceived pension wealth, particularly by workers that are better informed about their pension wealth. Klassifikation: E21, H55
This paper analyses the effects of the Initial Public Offering (IPO) market on real investment decisions in emerging industries. We first propose a model of IPO timing based on divergence of opinion among investors and short-sale constraints. Using a real option approach, we show that firms are more likely to go public when the ratio of overvaluation over profits is high, that is after stock market run-ups. Because initial returns increase with the demand from optimistic investors at the time of the offer, the model provides an explanation for the observed positive causality between average initial returns and IPO volume. Second, we discuss the possibility of real overinvestment in high-tech industries. We claim that investing in the industry gives agents an option to sell the project on the stock market at an overvalued price enabling then the financing of positive NPV projects which would not be undertaken otherwise. It is shown that the IPO market can however also lead to overinvestment in new industries. Finally, we present some econometric results supporting the idea that funds committed to the financing of high-tech industries may respond positively to optimistic stock market valuations.
A Corrigendum on Take a “Selfie”: Examining How Leaders Emerge From Leader Self-Awareness, Self-Leadership, and Self-Efficacy by Bracht, E. M., Keng-Highberger, F. T., Avolio, B. J., and Huang, Y. (2021). Front. Psychol. 12:635085. doi: 10.3389/fpsyg.2021.635085 In the original article, there was an error. The Ethics Statement incorrectly stated that “Ethical review and approval was not required for the study on human participants in accordance with the local legislation and institutional requirements. The patients/participants provided their written informed consent to participate in this study.” A correction has been made to the Ethics Statement. The corrected statement is shown below. The studies involving human participants were reviewed and approved by Nanyang Technological University (NTU) Institutional Review Board (IRB-2020-04-004). The participants provided their written informed consent to participate in this study. The authors apologize for this error and state that this does not change the scientific conclusions of the article in any way. The original article has been updated.
Innovation is considered essential for today's organizations to survive and thrive. Researchers have also stressed the importance of leadership as a driver of followers' innovative work behavior (FIB). Yet, despite a large amount of research, three areas remain understudied: (a) The relative importance of different forms of leadership for FIB; (b) the mechanisms through which leadership impacts FIB; and (c) the degree to which relationships between leadership and FIB are generalizable across cultures. To address these lacunae, we propose an integrated model connecting four types of positive leadership behaviors, two types of identification (as mediating variables), and FIB. We tested our model in a global data set comprising responses of N = 7,225 participants from 23 countries, grouped into nine cultural clusters. Our results indicate that perceived LMX quality was the strongest relative predictor of FIB. Furthermore, the relationships between both perceived LMX quality and identity leadership with FIB were mediated by social identification. The indirect effect of LMX on FIB via social identification was stable across clusters, whereas the indirect effects of the other forms of leadership on FIB via social identification were stronger in countries high versus low on collectivism. Power distance did not influence the relations.
The digitalization of financial services opened a window for new players in the financial industry. These start-ups take on tasks and functions previously reserved for banks, such as financing, asset management, and payments. In this article, we trace the transformation of the industry after digitalization. By using data on FinTech formations in Germany, we provide first evidence that entrepreneurial dynamics in the FinTech sector are not so much driven by technology as by the educational and business background of the founders. Furthermore, we investigate the reactions of traditional banks to the emergence of these start-ups. In contrast with other emerging industries such as biotechnology, a network analysis shows that FinTechs have mostly engaged in strategic partnerships and only a few banks have acquired or obtained a financial interest in a FinTech. We explain the restraint of traditional banks to fully endorse the new possibilities of digitalized financial services with the characteristics of the technology itself and with the postponed fundamental decisions of banks to modernize their IT infrastructure.
We extend the important idea of range-based volatility estimation to the multivariate case. In particular, we propose a range-based covariance estimator that is motivated by financial economic considerations (the absence of arbitrage), in addition to statistical considerations. We show that, unlike other univariate and multivariate volatility estimators, the range-based estimator is highly efficient yet robust to market microstructure noise arising from bid-ask bounce and asynchronous trading. Finally, we provide an empirical example illustrating the value of the high-frequency sample path information contained in the range-based estimates in a multivariate GARCH framework.
We provide a novel benefit of "Alternative Risk Transfer" (ART) products with parametric or index triggers. When a reinsurer has private information about his client's risk, outside reinsurers will price their reinsurance offer less aggressively. Outsiders are subject to adverse selection as only a high-risk insurer might find it optimal to change reinsurers. This creates a hold-up problem that allows the incumbent to extract an information rent. An information-insensitive ART product with a parametric or index trigger is not subject to adverse selection. It can therefore be used to compete against an informed reinsurer, thereby reducing the premium that a low-risk insurer has to pay for the indemnity contract. However, ART products exhibit an interesting fate in our model as they are useful, but not used in equilibrium because of basis-risk. Klassifikation: D82, G22
This paper deals with the superhedging of derivatives and with the corresponding price bounds. A static superhedge results in trivial and fully nonparametric price bounds, which can be tightened if there exists a cheaper superhedge in the class of dynamic trading strategies. We focus on European path-independent claims and show under which conditions such an improvement is possible. For a stochastic volatility model with unbounded volatility, we show that a static superhedge is always optimal, and that, additionally, there may be infinitely many dynamic superhedges with the same initial capital. The trivial price bounds are thus the tightest ones. In a model with stochastic jumps or non-negative stochastic interest rates either a static or a dynamic superhedge is optimal. Finally, in a model with unbounded short rates, only a static superhedge is possible.
We analyze the equilibrium in a two-tree (sector) economy with two regimes. The output of each tree is driven by a jump-diffusion process, and a downward jump in one sector of the economy can (but need not) trigger a shift to a regime where the likelihood of future jumps is generally higher. Furthermore, the true regime is unobservable, so that the representative Epstein-Zin investor has to extract the probability of being in a certain regime from the data. These two channels help us to match the stylized facts of countercyclical and excessive return volatilities and correlations between sectors. Moreover, the model reproduces the predictability of stock returns in the data without generating consumption growth predictability. The uncertainty about the state also reduces the slope of the term structure of equity. We document that heterogeneity between the two sectors with respect to shock propagation risk can lead to highly persistent aggregate price-dividend ratios. Finally, the possibility of jumps in one sector triggering higher overall jump probabilities boosts jump risk premia while uncertainty about the regime is the reason for sizeable diffusive risk premia.
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).
We analyze the implications of the structure of a network for asset prices in a general equilibrium model. Networks are represented via self- and mutually exciting jump processes, and the representative agent has Epstein-Zin preferences. Our approach provides a exible and tractable unifying foundation for asset pricing in networks. The model endogenously generates results in accordance with, e.g., the robust-yetfragile feature of financial networks shown in Acemoglu, Ozdaglar, and Tahbaz-Salehi (2014) and the positive centrality premium documented in Ahern (2013). We also show that models with simpler preference assumptions cannot generate all these findings simultaneously.
We study the effects of market incompleteness on speculation, investor survival, and asset pricing moments, when investors disagree about the likelihood of jumps and have recursive preferences. We consider two models. In a model with jumps in aggregate consumption, incompleteness barely matters, since the consumption claim resembles an insurance product against jump risk and effectively reproduces approximate spanning. In a long-run risk model with jumps in the long-run growth rate, market incompleteness affects speculation, and investor survival. Jump and diffusive risks are more balanced regarding their importance and, therefore, the consumption claim cannot reproduce approximate spanning.
Stocks are exposed to the risk of sudden downward jumps. Additionally, a crash in one stock (or index) can increase the risk of crashes in other stocks (or indices). Our paper explicitly takes this contagion risk into account and studies its impact on the portfolio decision of a CRRA investor both in complete and in incomplete market settings. We find that the investor significantly adjusts his portfolio when contagion is more likely to occur. Capturing the time dimension of contagion, i.e. the time span between jumps in two stocks or stock indices, is thus of first-order importance when analyzing portfolio decisions. Investors ignoring contagion completely or accounting for contagion while ignoring its time dimension suffer large and economically significant utility losses. These losses are larger in complete than in incomplete markets, and the investor might be better off if he does not trade derivatives. Furthermore, we emphasize that the risk of contagion has a crucial impact on investors' security demands, since it reduces their ability to diversify their portfolios.
This paper analyzes the equilibrium pricing implications of contagion risk in a Lucas-tree economy with recursive preferences and jumps. We introduce a new economic channel allowing for the possibility that endowment shocks simultaneously trigger a regime shift to a bad economic state. We document that these contagious jumps have far-reaching asset pricing implications. The risk premium for such shocks is superadditive, i.e. it is 2.5\% larger than the sum of the risk premia for pure endowment shocks and regime switches. Moreover, contagion risk reduces the risk-free rate by around 0.5\%. We also derive semiclosed-form solutions for the wealth-consumption ratio and the price-dividend ratios in an economy with two Lucas trees and analyze cross-sectional effects of contagion risk qualitatively. We find that heterogeneity among the assets with respect to contagion risk can increase risk premia disproportionately. In particular, big assets with a large exposure to contagious shocks carry significantly higher risk premia.
This paper analyzes the equilibrium pricing implications of contagion risk in a two-tree Lucas economy with CRRA preferences. The dividends of both trees are subject to downward jumps. Some of these jumps are contagious and increase the risk of subsequent jumps in both trees for some time interval. We show that contagion risk leads to large price-dividend ratios for small assets, a joint movement of prices in the case of a regime change from the calm to the contagion state, significantly positive correlations between assets, and large positive betas for small assets. Whereas disparities between the assets with respect to their propensity to trigger contagion barely matter for pricing, the prices of robust assets that are hardly affected by contagion and excitable assets that are severely hit by contagion differ significantly. Both in absolute terms and relatively to the market, the price of a small safe haven increases if the economy reaches the contagion state. On the contrary, the price of a small, contagion-sensitive asset exhibits a pronounced downward jump.
There has been a considerable debate about whether disaster models can rationalize the equity premium puzzle. This is because empirically disasters are not single extreme events, but long-lasting periods in which moderate negative consumption growth realizations cluster. Our paper proposes a novel way to explain this stylized fact. By allowing for consumption drops that can spark an economic crisis, we introduce a new economic channel that combines long-run and short-run risk. First, we document that our model can match consumption data of several countries. Second, it generates a large equity risk premium even if consumption drops are of moderate size.
Tractable hedging - an implementation of robust hedging strategies : [This Version: March 30, 2004]
(2004)
This paper provides a theoretical and numerical analysis of robust hedging strategies in diffusion–type models including stochastic volatility models. A robust hedging strategy avoids any losses as long as the realised volatility stays within a given interval. We focus on the effects of restricting the set of admissible strategies to tractable strategies which are defined as the sum over Gaussian strategies. Although a trivial Gaussian hedge is either not robust or prohibitively expensive, this is not the case for the cheapest tractable robust hedge which consists of two Gaussian hedges for one long and one short position in convex claims which have to be chosen optimally.
We propose a long-run risk model with stochastic volatility, a time-varying mean reversion level of volatility, and jumps in the state variables. The special feature of our model is that the jump intensity is not affine in the conditional variance but driven by a separate process. We show that this separation of jump risk from volatility risk is needed to match the empirically weak link between the level and the slope of the implied volatility smile for S&P 500 options.
This paper provides an in-depth analysis of the properties of popular tests for the existence and the sign of the market price of volatility risk. These tests are frequently based on the fact that for some option pricing models under continuous hedging the sign of the market price of volatility risk coincides with the sign of the mean hedging error. Empirically, however, these tests suffer from both discretization error and model mis-specification. We show that these two problems may cause the test to be either no longer able to detect additional priced risk factors or to be unable to identify the sign of their market prices of risk correctly. Our analysis is performed for the model of Black and Scholes (1973) (BS) and the stochastic volatility (SV) model of Heston (1993). In the model of BS, the expected hedging error for a discrete hedge is positive, leading to the wrong conclusion that the stock is not the only priced risk factor. In the model of Heston, the expected hedging error for a hedge in discrete time is positive when the true market price of volatility risk is zero, leading to the wrong conclusion that the market price of volatility risk is positive. If we further introduce model mis-specification by using the BS delta in a Heston world we find that the mean hedging error also depends on the slope of the implied volatility curve and on the equity risk premium. Under parameter scenarios which are similar to those reported in many empirical studies the test statistics tend to be biased upwards. The test often does not detect negative volatility risk premia, or it signals a positive risk premium when it is truly zero. The properties of this test furthermore strongly depend on the location of current volatility relative to its long-term mean, and on the degree of moneyness of the option. As a consequence tests reported in the literature may suffer from the problem that in a time-series framework the researcher cannot draw the hedging errors from the same distribution repeatedly. This implies that there is no guarantee that the empirically computed t-statistic has the assumed distribution. JEL: G12, G13 Keywords: Stochastic Volatility, Volatility Risk Premium, Discretization Error, Model Error
Tests for the existence and the sign of the volatility risk premium are often based on expected option hedging errors. When the hedge is performed under the ideal conditions of continuous trading and correct model specification, the sign of the premium is the same as the sign of the mean hedging error for a large class of stochastic volatility option pricing models. We show, however, that the problems of discrete trading and model mis-specification, which are necessarily present in any empirical study, may cause the standard test to yield unreliable results.
When options are traded, one can use their prices and price changes to draw inference about the set of risk factors and their risk premia. We analyze tests for the existence and the sign of the market prices of jump risk that are based on option hedging errors. We derive a closed-form solution for the option hedging error and its expectation in a stochastic jump model under continuous trading and correct model specification. Jump risk is structurally different from, e.g., stochastic volatility: there is one market price of risk for each jump size (and not just \emph{the} market price of jump risk). Thus, the expected hedging error cannot identify the exact structure of the compensation for jump risk. Furthermore, we derive closed form solutions for the expected option hedging error under discrete trading and model mis-specification. Compared to the ideal case, the sign of the expected hedging error can change, so that empirical tests based on simplifying assumptions about trading frequency and the model may lead to incorrect conclusions.
n this paper we analyze an economy with two heterogeneous investors who both exhibit misspecified filtering models for the unobservable expected growth rate of the aggregated dividend. A key result of our analysis with respect to long-run investor survival is that there are degrees of model misspecification on the part of one investor for which there is no compensation by the other investor's deficiency. The main finding with respect to the asset pricing properties of our model is that the two dimensions of asset pricing and survival are basically independent. In scenarios when the investors are more similar with respect to their expected consumption shares, return volatilities can nevertheless be higher than in cases when they are very different.
The uphill challenge
(2017)
Does exchange of information between tax authorities influence multinationals' use of tax havens?
(2015)
Since the mid-1990s, countries offering tax systems that facilitate international tax avoidance and evasion have been facing growing political pressure to comply with the internationally agreed standards of exchange of tax information. Using data of German investments in tax havens, we find evidence that the conclusion of a bilateral tax information exchange agreement (TIEA) is associated with fewer operations in tax havens and the number of German affiliates has on average decreased by 46% compared to a control group. This suggests that firms invest in tax havens not only for their low tax rates but also for the secrecy they offer.
THIS STUDY DOCUMENTS THE ROLE OF BARGAINING POWER IN THE DETERMINATION OF
MORTGAGE RATES BASED ON A UNIQUE ADMINISTRATIVE DATA SET COMPRISING 20,000
MORTGAGE LOAN CONTRACTS. WE USE VARIATION IN THE COMPETITIVE ENVIRONMENT
TO IDENTIFY THE EXTENT TO WHICH DIFFERENTIAL PRICING IS DUE TO RELATIVE BARGAINING POWER. OUR IDENTIFICATION STRATEGY SEPARATES MARKET POWER FROM OTHER SOURCES OF PRICING DIFFERENTIALS, SUCH AS CREDIT RISK, PRODUCT DIFFERENTIATION, OR OTHER COSTS. THE RESULTS INDICATE THAT BARGAINING POWER DETERMINES THE EXTENT OF PRICE DISCRIMINATION ON OBSERVABLE BORROWER CHARACTERISTICS. A REDUCTION IN LENDER BARGAINING POWER REDUCES THE DISADVANTAGE SUFFERED BY BORROWERS WHO REFINANCE THEIR LOAN AND REDUCES THE ADVANTAGE FOR THOSE WHO HAVE THEIR MAIN BANKING RELATIONSHIP AT ANOTHER BANK. SIMULTANEOUSLY, IT INCREASES THE ADVANTAGE FOR BORROWERS FALLING IN THE WEALTHY/HIGH-INCOME SEGMENT. FURTHER ANALYSES POINT TO SEARCH INCENTIVES AS AN IMPORTANT DRIVER OF THE DIRECTION OF THE EFFECT OF BARGAINING POWER.