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236
Asset transaction prices sampled at high frequency are much staler than one might expect in the sense that they frequently lack new updates showing zero returns. In this paper, we propose a theoretical framework for formalizing this phenomenon. It hinges on the existence of a latent continuous-time stochastic process pt valued in the open interval (0; 1), which represents at any point in time the probability of the occurrence of a zero return. Using a standard infill asymptotic design, we develop an inferential theory for nonparametrically testing, the null hypothesis that pt is constant over one day. Under the alternative, which encompasses a semimartingale model for pt, we develop non-parametric inferential theory for the probability of staleness that includes the estimation of various integrated functionals of pt and its quadratic variation. Using a large dataset of stocks, we provide empirical evidence that the null of the constant probability of staleness is fairly rejected. We then show that the variability of pt is mainly driven by transaction volume and is almost unaffected by bid-ask spread and realized volatility.
233
This paper presents new evidence on the expectation formation process from a Dutch household survey. Households become too optimistic about their future income after their income has improved, consistent with the over-extrapolation of their experience. We show that this effect of experience is persistent and that households over-extrapolate income losses more than income gains. Furthermore, older households over-extrapolate more, suggesting that they did not learn over time to form more accurate expectations. Finally, we study the relationship between expectation errors and consumption. We find that more over-optimistic households intend to consume more and subsequently report higher consumption, even though they do not consume as much as they intended to. These results suggests that overextrapolation hurts consumers and amplify business cycles.
239
Higher capital ratios are believed to improve system-wide financial stability through three main channels: (i) higher loss-absorption capacity, (ii) lower moral hazard, (iii) stabilization of the financial cycle if capital ratios are increased during good times. We examine these mechanisms in a laboratory asset market experiment with indebted participants. We find support for the loss-absorption channel: higher capital ratios reduce the bankruptcy rate. However, we do not find support for the moral hazard channel. Higher capital ratios (insignificantly) increase asset price bubbles, an aggregate measure of excessive risk-taking. Additional evidence suggests that bankruptcy aversion explains this surprising result. Finally, the evidence supports the idea that higher capital ratios in good times stabilize the financial cycle.
205
In contrast to the popularity of financial education interventions worldwide, studies on the economic effects of those interventions report mixed results. With a focus on the effect on disadvantaged groups, we review both the theoretical and empirical findings in order to understand why this discrepancy exists. The survey first highlights that it is necessary to distinguish between the concepts of, and the relationships between, financial education, financial literacy and financial behavior to identify the true effects of financial education. The review addresses possible biases caused by third factors such as numeracy. Next, we review theories on financial literacy which make clear that the effect of financial education interventions is heterogeneous across the population. Last, we look closely at main empirical studies on financial education targeted at the migrants/immigrants, the low-income earners and the young, and compare their methodologies. There seems to be a positive effect on short-term financial knowledge and awareness of the young, but there is no proven evidence on long-term behavior after being grown up. Studies on financial behavior of migrants and immigrants show almost no effect of financial education.
209
This paper studies the distributional consequences of a systematic variation in expenditure shares and prices. Using European Union Household Budget Surveys and Harmonized Index of Consumer Prices data, we construct household-specific price indices and reveal the existence of a pro-rich inflation in Europe. Particularly, over the period 2001-15, the consumption bundles of the poorest deciles in 25 European countries have, on average, become 10.5 percentage points more expensive than those of the richest decile. We find that ignoring the differential inflation across the distribution underestimates the change in the Gini (based on consumption expenditure) by up to 0.03 points. Cross-country heterogeneity in this change is large enough to alter the inequality ranking of numerous countries. The average inflation effect we detect is almost as large as the change in the standard Gini measure over the period of interest.
208
The paper analyses the contagion channels of the European financial system through the stochastic block model (SBM). The model groups homogeneous connectivity patterns among the financial institutions and describes the shock transmission mechanisms of the financial networks in a compact way. We analyse the global financial crisis and European sovereign debt crisis and show that the network exhibits a strong community structure with two main blocks acting as shock spreader and receiver, respectively. Moreover, we provide evidence of the prominent role played by insurances in the spread of systemic risk in both crises. Finally, we demonstrate that policy interventions focused on institutions with inter-community linkages (community bridges) are more effective than the ones based on the classical connectedness measures and represents consequently, a better early warning indicator in predicting future financial losses.
227
We study the role of various trader types in providing liquidity in spot and futures markets based on complete order-book and transactions data as well as cross-market trader identifiers from the National Stock Exchange of India for a single large stock. During normal times, short-term traders who carry little inventory overnight are the primary intermediaries in both spot and futures markets, and changes in futures prices Granger-cause changes in spot prices. However, during two days of fast crashes, Granger-causality ran both ways. Both crashes were due to large-scale selling by foreign institutional investors in the spot market. Buying by short-term traders and cross-market traders was insufficient to stop the crashes. Mutual funds, patient traders with better trade-execution quality who were initially slow to move in, eventually bought sufficient quantities leading to price recovery in both markets. Our findings suggest that market stability requires the presence of well-capitalized standby liquidity providers.
210
We show that time-varying volatility of volatility is a significant risk factor which affects the cross-section and the time-series of index and VIX option returns, beyond volatility risk itself. Volatility and volatility-of-volatility measures, identified model-free from the option price data as the VIX and VVIX indices, respectively, are only weakly related to each other. Delta-hedged index and VIX option returns are negative on average, and are more negative for strategies which are more exposed to volatility and volatility-of-volatility risks. Volatility and volatility of volatility significantly and negatively predict future delta-hedged option payoffs. The evidence is consistent with a no-arbitrage model featuring time-varying market volatility and volatility-of-volatility factors, both of which have negative market price of risk.
215
In the last decade, central bank interventions, flights to safety, and the shift in derivatives clearing resulted in exceptionally high demand for high quality liquid assets, such as German treasuries, in the securities lending market besides the traditional repo market activities. Despite the high demand, the realizable securities lending income has remained economically negligible for most beneficial owners. We provide empirical evidence of pricing inefficiencies in the non-transparent, oligopolistic securities lending market for German treasuries from 2006 to 2015. Consistent with Duffie, Gârleanu and Pedersen (2005)’s theory, we find that the less connected market participants’ interests are underrepresented, evident in the longer maturity segment, where lenders are more likely to be conservative passive investors, such as pension funds and insurance firms. The low price elasticity in this segment hinders these beneficial owners to fully capitalize on the additional income from securities lending, giving rise to important negative welfare implications.
193
This paper analyses whether the post-crisis regulatory reforms developed by global-standard-setting bodies have created appropriate incentives for different types of market participants to centrally clear Over-The-Counter (OTC) derivative contracts. Beyond documenting the observed facts, we analyze four main drivers for the decision to clear: 1) the liquidity and riskiness of the reference entity; 2) the credit risk of the counterparty; 3) the clearing member’s portfolio net exposure with the Central Counterparty Clearing House (CCP) and 4) post trade transparency. We use confidential European trade repository data on single-name Sovereign Credit Derivative Swap (CDS) transactions, and show that for all the transactions reported in 2016 on Italian, German and French Sovereign CDS 48% were centrally cleared, 42% were not cleared despite being eligible for central clearing, while 9% of the contracts were not clearable because they did not satisfy certain CCP clearing criteria. However, there is a large difference between CCP clearing members that clear about 53% of their transactions and non-clearing members, even those that are subject to counterparty risk capital requirements, that almost never clear their trades. Moreover, we find that diverse factors explain clearing members’ decision to clear different CDS contracts: for Italian CDS, counterparty credit risk exposures matter most for the decision to clear, while for French and German CDS, margin costs are the most important factor for the decision. Clearing members use clearing to reduce their exposures to the CCP and largely clear contracts when at least one of the traders has a high counterparty credit risk.
228
The paper investigates the determinants of the idiosyncratic volatility puzzle by allowing linkages across asset returns. The first contribution of the paper is to show that portfolios sorted by increasing indegree computed on the network based on Granger causality test have lower expected returns, not related to idiosyncratic volatility. Secondly, empirical evidence indicates that stocks with higher idiosyncratic volatility have the lower exposition on the indegree risk factor.
235
Through the lens of market participants' objective to minimize counterparty risk, we provide an explanation for the reluctance to clear derivative trades in the absence of a central clearing obligation. We develop a comprehensive understanding of the benefits and potential pitfalls with respect to a single market participant's counterparty risk exposure when moving from a bilateral to a clearing architecture for derivative markets. Previous studies suggest that central clearing is beneficial for single market participants in the presence of a sufficiently large number of clearing members. We show that three elements can render central clearing harmful for a market participant's counterparty risk exposure regardless of the number of its counterparties: 1) correlation across and within derivative classes (i.e., systematic risk), 2) collateralization of derivative claims, and 3) loss sharing among clearing members. Our results have substantial implications for the design of derivatives markets, and highlight that recent central clearing reforms might not incentivize market participants to clear derivatives.
238
Much ado about nothing : a study of differential pricing and liquidity of short and long term bonds
(2018)
Are yields of long-maturity bonds distorted by demand pressure of clientele investors, regulatory effects, or default, flight-to-safety or liquidity premiums? Using data on German nominal bonds between 2005 and 2015, we study the differential pricing and liquidity of short and long maturity bonds. We find statistically significant, but economically negligible segmentation in yields and some degree of liquidity segmentation of short-term versus long-term bonds. These results have important policy implications for the e17.5 trillion European pension and insurance industries: long maturity bond yields seem appropriate for the valuation of long-term liabilities.
224
An important assumption underlying the designation of some insurers as systemically important is that their overlapping portfolio holdings can result in common selling. We measure the overlap in holdings using cosine similarity, and show that insurers with more similar portfolios have larger subsequent common sales. This relationship can be magnified for some insurers when they are regulatory capital constrained or markets are under stress. When faced with an exogenous liquidity shock, insurers with greater portfolio similarity have even larger common sales that impact prices. Our measure can be used by regulators to predict which institutions may contribute most to financial instability through the asset liquidation channel of risk transmission.
214
In this study we investigate which economic ideas were prevalent in the macroprudential discourse post-crises in order to understand the availability of ideas for reform minded agents. We base our analysis on new findings in the field of ideational shifts and regulatory science, which posit that change-agents engage with new ideas pragmatically and strategically in their effort to have their economic ideas institutionalized. We argue that in these epistemic battles over new regulation, scientific backing by academia is the key resource determining the outcome. We show that the present reforms implemented internationally follow this pattern. In our analysis we contrast the entire discourse on systemic risk and macroprudential regulation with Borio’s initial 2003 proposal for a macroprudential framework. We find that mostly cross-sectional measures targeted towards increasing the resilience of the financial system rather than inter-temporal measures dampening the financial cycle have been implemented. We provide evidence for the lacking support of new macroprudential thinking within academia and argue that this is partially responsible for the lack of anti-cyclical macroprudential regulation. Most worryingly, the financial cycle is largely absent in the academic discourse and is only tacitly assumed instead of fully fledged out in technocratic discourses, pointing to the possibility that no anti-cyclical measures will be forthcoming.
237
A number of recent studies have concluded that consumer spending patterns over the month are closely linked to the timing of income receipt. This correlation is interpreted as evidence of hyperbolic discounting. I re-examine patterns of spending in the diary sample of the U.S. Consumer Expenditure Survey, incorporating information on the timing of the main consumption commitment for most households - their monthly rent or mortgage payment. I find that non-durable and food spending increase with 30-48% on the day housing payments are made, with smaller increases in the days after. Moreover, households with weekly, biweekly and monthly income streams but the same timing of rent/mortgage payments have very similar consumption patterns. Exploiting variation in income, I find that households with extra liquidity decrease non-durable spending around housing payments, especially those households with a large budget share of housing.
195
We investigate different designs of circuit breakers implemented on European trading venues and examine their effectiveness to manage excess volatility and to preserve liquidity. Specifically, we empirically analyze volatility and liquidity around volatility interruptions implemented on the German and Spanish stock market which differ regarding specific design parameters. We find that volatility interruptions in general significantly decrease volatility in the post interruption phase. Unfortunately, this decrease in volatility comes at the cost of decreased liquidity. Regarding design parameters, we find tighter price ranges and shorter durations to support volatility interruptions in achieving their goals.
231
We study the introduction of single-market liquidity provider incentives in fragmented securities markets. Specifically, we investigate whether fee rebates for liquidity providers enhance liquidity on the introducing market and thereby increase its competitiveness and market share. Further, we analyze whether single-market liquidity provider incentives increase overall market liquidity available for market participants. Therefore, we measure the specific liquidity contribution of individual markets to the aggregate liquidity in the fragmented market environment. While liquidity and market share of the venue introducing incentives increase, we find no significant effect for turnover and liquidity of the whole market.
196
Coordination of circuit breakers? Volume migration and volatility spillover in fragmented markets
(2018)
We study circuit breakers in a fragmented, multi-market environment and investigate whether a coordination of circuit breakers is necessary to ensure their effectiveness. In doing so, we analyze 2,337 volatility interruptions on Deutsche Boerse and research whether a volume migration and an accompanying volatility spillover to alternative venues that continue trading can be observed. Different to prevailing theoretical rationale, trading volume on alternative venues significantly decreases during circuit breakers on the main market and we do not find any evidence for volatility spillover. Moreover, we show that the market share of the main market increases sharply during a circuit breaker. Surprisingly, this is amplified with increasing levels of fragmentation. We identify high-frequency trading as a major reason for the vanishing trading activity on the alternative venues and give empirical evidence that a coordination of circuit breakers is not essential for their effectiveness as long as market participants shift to the dominant venue during market stress.