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280
Consuming dividends
(2020)
This paper studies why investors buy dividend-paying assets and how they time their consumption accordingly. We combine administrative bank data linking customers’ consumption transactions and income to detailed portfolio data and survey responses on financial behavior. We find that private consumption is excessively sensitive to dividend income. Investors across wealth, income, and age distributions increase spending precisely around days of dividend receipt. Importantly, the consumption response is driven by financially prudent investors who select dividend portfolios, anticipate dividend income, and plan consumption accordingly. Our results contribute to the literature on a dividend clientele and provide evidence of ‘planned’ excess sensitivity.
86
Based on a sample of university students, we provide field and laboratory evidence that a small scale training intervention has a both statistically and economically significant effect on subjective and objective assessments of financial knowledge. We also show that for a large part of students whose self-assessed financial knowledge has improved we do not find an increase in their actual skills.
26
In this paper we provide new evidence that corporate financing decisions are associated with managerial incentives to report high equity earnings. Managers rely most heavily on debt to finance their asset growth when their future earnings prospects are poor, when they are under pressure due to past declines in earnings, negative past stock returns, and excessively optimistic analyst earnings forecasts, and when the earnings yield is high relative to bond yields so that from an accounting perspective equity is ‘expensive’. Managers of high debt issuing firms are more likely to be newly appointed and also more likely to be replaced in subsequent years. Abnormal returns on portfolios formed on the basis of asset growth and debt issuance are strongly positively associated with the contemporaneous changes in returns on assets and on equity as well as with earnings surprises. This may account for the finding that debt issuance forecasts negative abnormal returns, since debt issuance also forecasts negative changes in returns on assets and on equity and negative earnings surprises. Different mechanisms appear to be at work for firms that retire debt.
119
We offer evidence of a new stylized feature of corporate financing decisions: the tendency of managers to rely more on debt financing when earnings prospects are poor. We term this 'leaning against the wind' and consider three possible explanations: market timing, precautionary financing, and 'making the numbers'. We find no evidence in favor of the first two hypotheses, and provisionally accept the 'making the numbers' hypothesis that managers who are under pressure because of unrealistically optimistic earnings expectations by analysts and deteriorating real opportunities, will rely more heavily on debt financing to boost earnings per share and return on equity.
89
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.
114
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.
186
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.
28
This paper compares two classes of models that allow for additional channels of correlation between asset returns: regime switching models with jumps and models with contagious jumps. Both classes of models involve a hidden Markov chain that captures good and bad economic states. The distinctive feature of a model with contagious jumps is that large negative returns and unobservable transitions of the economy into a bad state can occur simultaneously. We show that in this framework the filtered loss intensities have dynamics similar to self-exciting processes. Besides, we study the impact of unobservable contagious jumps on optimal portfolio strategies and filtering.
11
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.
11 [neue Version]
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.
252
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.
74
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.
131
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).
34
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.
77
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.
165
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.
48
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.
12
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.
46
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.
117
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.
266
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.
283
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.
81
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.
96
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?
304
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.
415
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.
159
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.
261
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.
352
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.
284
We analyze the ESG rating criteria used by prominent agencies and show that there is a lack of a commonality in the definition of ESG (i) characteristics, (ii) attributes and (iii) standards in defining E, S and G components. We provide evidence that heterogeneity in rating criteria can lead agencies to have opposite opinions on the same evaluated companies and that agreement across those providers is substantially low. Those alternative definitions of ESG also a↵ect sustainable investments leading to the identification of di↵erent investment universes and consequently to the creation of di↵erent benchmarks. This implies that in the asset management industry it is extremely dicult to measure the ability of a fund manager if financial performances are strongly conditioned by the chosen ESG benchmark. Finally, we find that the disagreement in the scores provided by the rating agencies disperses the e↵ect of preferences of ESG investors on asset prices, to the point that even when there is agreement, it has no impact on financial performances.
349
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.
403
Measuring and reducing energy consumption constitutes a crucial concern in public policies aimed at mitigating global warming. The real estate sector faces the challenge of enhancing building efficiency, where insights from experts play a pivotal role in the evaluation process. This research employs a machine learning approach to analyze expert opinions, seeking to extract the key determinants influencing potential residential building efficiency and establishing an efficient prediction framework. The study leverages open Energy Performance Certificate databases from two countries with distinct latitudes, namely the UK and Italy, to investigate whether enhancing energy efficiency necessitates different intervention approaches. The findings reveal the existence of non-linear relationships between efficiency and building characteristics, which cannot be captured by conventional linear modeling frameworks. By offering insights into the determinants of residential building efficiency, this study provides guidance to policymakers and stakeholders in formulating effective and sustainable strategies for energy efficiency improvement.
166
The impact of network connectivity on factor exposures, asset pricing and portfolio diversification
(2017)
This paper extends the classic factor-based asset pricing model by including network linkages in linear factor models. We assume that the network linkages are exogenously provided. This extension of the model allows a better understanding of the causes of systematic risk and shows that (i) network exposures act as an inflating factor for systematic exposure to common factors and (ii) the power of diversification is reduced by the presence of network connections. Moreover, we show that in the presence of network links a misspecified traditional linear factor model presents residuals that are correlated and heteroskedastic. We support our claims with an extensive simulation experiment.
225
We propose a spatiotemporal approach for modeling risk spillovers using time-varying proximity matrices based on observable financial networks and introduce a new bilateral specification. We study covariance stationarity and identification of the model, and analyze consistency and asymptotic normality of the quasi-maximum-likelihood estimator. We show how to isolate risk channels and we discuss how to compute target exposure able to reduce system variance. An empirical analysis on Euro-area cross-country holdings shows that Italy and Ireland are key players in spreading risk, France and Portugal are the major risk receivers, and we uncover Spain's non-trivial role as risk middleman.
69
We examine the relationship between household wealth and self-control. Although self-control has been linked to consumption and financial behavior, its measurement remains an open issue. We employ a definition of self-control failure that follows literature in psychology, suggesting that three factors can render self-control defective: lack of planning, lack of monitoring, and lack of commitment to pre-set plans. Our measure combines those three ingredients and can be computed using a standard representative survey. We find that self-control failure is strongly associated with different household net wealth measures and with self-assessed financial distress.
126
Private equity fund managers are typically required to invest their own money alongside the fund. We examine how this coinvestment affects the acquisition strategy of leveraged buyout funds. In a simple model, where the investment and capital structure decisions are made simultaneously, we show that a higher coinvestment induces managers to chose less risky firms and use more leverage. We test these predictions in a unique sample of private equity investments in Norway, where the fund manager's taxable wealth is publicly available. Consistent with the model, portfolio company risk decreases and leverage ratios increase with the coinvestment fraction of the manager's wealth. Moreover, funds requiring a relatively high coinvestment tend to spread its capital over a larger number of portfolio firms, consistent with a more conservative investment policy.
361
This paper utilizes a comprehensive worker-firm panel for the Netherlands to quantifythe impact of ICT capital-skill complementarity on the finance wage premium after the Global Financial Crisis. We apply additive worker and firm fixed-effect models to account for unobserved worker- and firm-heterogeneity and show that firm fixed-effects correct for a downward bias in the estimated finance wage premium. Our results indicate a sizable finance wage premium for both fixed- and full-hourly wages. The complementarity between ICT capital spending and the share of high skill workers at the firm-level reduces the full-wage premium considerably and the fixed-wage premium almost entirely.
244
We propose a shrinkage and selection methodology specifically designed for network inference using high dimensional data through a regularised linear regression model with Spike-and-Slab prior on the parameters. The approach extends the case where the error terms are heteroscedastic, by adding an ARCH-type equation through an approximate Expectation-Maximisation algorithm. The proposed model accounts for two sets of covariates. The first set contains predetermined variables which are not penalised in the model (i.e., the autoregressive component and common factors) while the second set of variables contains all the (lagged) financial institutions in the system, included with a given probability. The financial linkages are expressed in terms of inclusion probabilities resulting in a weighted directed network where the adjacency matrix is built “row by row". In the empirical application, we estimate the network over time using a rolling window approach on 1248 world financial firms (banks, insurances, brokers and other financial services) both active and dead from 29 December 2000 to 6 October 2017 at a weekly frequency. Findings show that over time the shape of the out degree distribution exhibits the typical behavior of financial stress indicators and represents a significant predictor of market returns at the first lag (one week) and the fourth lag (one month).
305
The disposition effect is implicitly assumed to be constant over time. However, drivers of the disposition effect (preferences and beliefs) are rather countercyclical. We use individual investor trading data covering several boom and bust periods (2001-2015). We show that the disposition effect is countercyclical, i.e. is higher in bust than in boom periods. Our findings are driven by individuals being 25% more likely to realize gains in bust than in boom periods. These changes in investors’ selling behavior can be linked to changes in investors’ risk aversion and in their beliefs across financial market cycles.
378
Using German and US brokerage data we find that investors are more likely to sell speculative stocks trading at a gain. Investors’ gain realizations are monotonically increasing in a stock’s speculativeness. This translates into a high disposition effect for speculative and a much lower disposition effect for non-speculative stocks. Our findings hold across asset classes (stocks, passive, and active funds) and explain cross-sectional differences in investor selling behavior which previous literature attributed primarily to investor demographics. Our results are robust to rank or attention effects and can be linked to realization utility and rolling mental account.
234
A tale of one exchange and two order books : effects of fragmentation in the absence of competition
(2018)
Exchanges nowadays routinely operate multiple, almost identically structured limit order markets for the same security. We study the effects of such fragmentation on market performance using a dynamic model where agents trade strategically across two identically-organized limit order books. We show that fragmented markets, in equilibrium, offer higher welfare to intermediaries at the expense of investors with intrinsic trading motives, and lower liquidity than consolidated markets. Consistent with our theory, we document improvements in liquidity and lower profits for liquidity providers when Euronext, in 2009, consolidated its order ow for stocks traded across two country-specific and identically-organized order books into a single order book. Our results suggest that competition in market design, not fragmentation, drives previously documented improvements in market quality when new trading venues emerge; in the absence of such competition, market fragmentation is harmful.
423
This paper examines the dynamic relationship between firm leverage and risktaking. We embed the traditional agency problem of asset substitution within a multi-period model, revealing a U-shaped relationship between leverage and risktaking, evident in data from both the U.S. and Europe. Firms with medium leverage avoid risk to preserve the option of issuing safe debt in the future. This option is valuable because safe debt does not incur the expected cost of bankruptcy, anticipated by debt-holders due to future risk-taking incentives. Our model offers new insights on the interaction between companies' debt financing and their risk profiles.
121
This paper investigates systemic risk in the insurance industry. We first analyze the systemic contribution of the insurance industry vis-à-vis other industries by applying 3 measures, namely the linear Granger causality test, conditional value at risk and marginal expected shortfall, on 3 groups, namely banks, insurers and non-financial companies listed in Europe over the last 14 years. We then analyze the determinants of the systemic risk contribution within the insurance industry by using balance sheet level data in a broader sample. Our evidence suggests that i) the insurance industry shows a persistent systemic relevance over time and plays a subordinate role in causing systemic risk compared to banks, and that ii) within the industry, those insurers which engage more in non-insurance-related activities tend to pose more systemic risk. In addition, we are among the first to provide empirical evidence on the role of diversification as potential determinant of systemic risk in the insurance industry. Finally, we confirm that size is also a significant driver of systemic risk, whereas price-to-book ratio and leverage display counterintuitive results.
137
A stochastic forward-looking model to assess the profitability and solvency of european insurers
(2016)
In this paper, we develop an analytical framework for conducting forward-looking assessments of profitability and solvency of the main euro area insurance sectors. We model the balance sheet of an insurance company encompassing both life and non-life business and we calibrate it using country level data to make it representative of the major euro area insurance markets. Then, we project this representative balance sheet forward under stochastic capital markets, stochastic mortality developments and stochastic claims. The model highlights the potential threats to insurers solvency and profitability stemming from a sustained period of low interest rates particularly in those markets which are largely exposed to reinvestment risks due to the relatively high guarantees and generous profit participation schemes. The model also proves how the resilience of insurers to adverse financial developments heavily depends on the diversification of their business mix. Finally, the model identifies potential negative spillovers between life and non-life business thorugh the redistribution of capital within groups.
65
Low interest rates are becoming a threat to the stability of the life insurance industry, especially in countries such as Germany, where products with relatively high guaranteed returns sold in the past still represent a prominent share of the total portfolio. This contribution aims to assess and quantify the effects of the current low interest rate phase on the balance sheet of a representative German life insurer, given the current asset allocation and the outstanding liabilities. To do so, we generate a stochastic term structure of interest rates as well as stock market returns to simulate investment returns of a stylized life insurance business portfolio in a multi-period setting. Based on empirically calibrated parameters, we can observe the evolution of the life insurers' balance sheet over time with a special focus on their solvency situation. To account for different scenarios and in order to check the robustness of our findings, we calibrate different capital market settings and different initial situations of capital endowment. Our results suggest that a prolonged period of low interest rates would markedly affect the solvency situation of life insurers, leading to relatively high cumulative probability of default for less capitalized companies.
243
This paper examines how networks of professional contacts contribute to the development of the careers of executives of North American and European companies. We build a dynamic model of career progression in which career moves may both depend upon existing networks and contribute to the development of future networks. We test the theory on an original dataset of nearly 73 000 executives in over 10 000 _rms. In principle professional networks could be relevant both because they are rewarded by the employer and because they facilitate job mobility. Our econometric analysis suggests that, although there is a substantial positive correlation between network size and executive compensation, with an elasticity of around 20%, almost all of this is due to unobserved individual characteristics. The true causal impact of networks on compensation is closer to an elasticity of 1 or 2% on average, all of this due to enhanced probability of moving to a higher-paid job. And there appear to be strongly diminishing returns to network size.
182
Coming early to the party
(2017)
We examine the strategic behavior of High Frequency Traders (HFTs) during the pre-opening phase and the opening auction of the NYSE-Euronext Paris exchange. HFTs actively participate, and profitably extract information from the order flow. They also post "flash crash" orders, to gain time priority. They make profits on their last-second orders; however, so do others, suggesting that there is no speed advantage. HFTs lead price discovery, and neither harm nor improve liquidity. They "come early to the party", and enjoy it (make profits); however, they also help others enjoy the party (improve market quality) and do not have privileges (their speed advantage is not crucial).
247
Do competition and incentives offered to designated market makers (DMMs) improve market liquidity? Using data from NYSE Euronext Paris, we show that an exogenous increase in competition among DMMs leads to a significant decrease in quoted and effective spreads, mainly through a reduction in adverse selection costs. In contrast, changes in incentives, through small changes in rebates and requirements for DMMs, do not have any tangible effect on market liquidity. Our results are of relevance for designing optimal contracts between exchanges and DMMs and for regulatory market oversight.
144
We study whether the presence of low-latency traders (including high-frequency traders (HFTs)) in the pre-opening period contributes to market quality, defined by price discovery and liquidity provision, in the opening auction. We use a unique dataset from the Tokyo Stock Exchange (TSE) based on server-IDs and find that HFTs dynamically alter their presence in different stocks and on different days. In spite of the lack of immediate execution, about one quarter of HFTs participate in the pre-opening period, and contribute significantly to market quality in the pre-opening period, the opening auction that ensues and the continuous trading period. Their contribution is largely different from that of the other HFTs during the continuous period.
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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.