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162
Asymmetric social norms
(2017)
Studies of cooperation in infinitely repeated matching games focus on homogeneous economies, where full cooperation is efficient and any defection is collectively sanctioned. Here we study heterogeneous economies where occasional defections are part of efficient play, and show how to support those outcomes through contagious punishments.
189
This paper studies the long-run effects of credit market disruptions on real firm outcomes and how these effects depend on nominal wage rigidities at the firm level. I trace out the long-run investment and growth trajectories of firms which are more adversely affected by a transitory shock to aggregate credit supply. Affected firms exhibit a temporary investment gap for two years following the shock, resulting in a persistent accumulated growth gap. I show that affected firms with a higher degree of wage rigidity exhibit a steeper drop in investment and grow more slowly than affected firms with more flexible wages.
184
Crowdfunding is a buzzword that signifies a sub-set in the new forms of finance facilitated by advances in information technology usually categorized as fintech. Concerns for financial stability, investor and consumer protection, or the prevention of money laundering or funding of terrorism hinge incrementally on including the new techniques to initiate financing relationships adequately in the regulatory framework.
This paper analyzes the German regulation of crowdinvesting and finds that it does not fully live up to the regulatory challenges posed by this novel form of digitized matching of supply and demand on capital markets. It should better reflect the key importance of crowdinvesting platforms, which may become critical providers of market infrastructure in the not too distant future. Moreover, platforms can play an important role in investor protection that cannot be performed by traditional disclosure regimes geared towards more seasoned issuers. Against this background, the creation of an exemption from the traditional prospectus regime seems to be a plausible policy choice. However, it needs to be complemented by an adequate regulatory stimulation of platforms’ role as gatekeepers.
190
This Chapter explores how an environment of persistent low returns influences saving, investing, and retirement behaviors, as compared to what in the past had been thought of as more “normal” financial conditions. Our calibrated lifecycle dynamic model with realistic tax, minimum distribution, and Social Security benefit rules produces results that agree with observed saving, work, and claiming age behavior of U.S. households. In particular, our model generates a large peak at the earliest claiming age at 62, as in the data. Also in line with the evidence, our baseline results show a smaller second peak at the (system-defined) Full Retirement Age of 66. In the context of a zero-return environment, we show that workers will optimally devote more of their savings to non-retirement accounts and less to 401(k) accounts, since the relative appeal of investing in taxable versus tax-qualified retirement accounts is lower in a low return setting. Finally, we show that people claim Social Security benefits later in a low interest rate environment.
164
People who delay claiming Social Security receive higher lifelong benefits upon retirement. We survey individuals on their willingness to delay claiming later, if they could receive a lump sum in lieu of a higher annuity payment. Using a moment-matching approach, we calibrate a lifecycle model tracking observed claiming patterns under current rules and predict optimal claiming outcomes under the lump sum approach. Our model correctly predicts that early claimers under current rules would delay claiming most when offered actuarially fair lump sums, and for lump sums worth 87% as much, claiming ages would still be higher than at present.
168
We test two hypotheses, based on sexual selection theory, about gender differences in costly social interactions. Differential selectivity states that women invest less than men in interactions with new individuals. Differential opportunism states that women’s investment in social interactions is less responsive to information about the interaction’s payoffs. The hypotheses imply that women’s social networks are more stable and path dependent and composed of a greater proportion of strong relative to weak links. During their introductory week, we let new university students play an experimental trust game, first with one anonymous partner, then with the same and a new partner. Consistent with our hypotheses, we find that women invest less than men in new partners and that their investments are only half as responsive to information about the likely returns to the investment. Moreover, subsequent formation of students’ real social networks is consistent with the experimental results: being randomly assigned to the same introductory group has a much larger positive effect on women’s likelihood of reporting a subsequent friendship.
177
This paper examines the welfare implications of rising temperatures. Using a standard VAR, we empirically show that a temperature shock has a sizable, negative and statistically significant impact on TFP, output, and labor productivity. We rationalize these findings within a production economy featuring long-run temperature risk. In the model, macro-aggregates drop in response to a temperature shock, consistent with the novel evidence in the data. Such adverse effects are long-lasting. Over a 50-year horizon, a one-standard deviation temperature shock lowers both cumulative output and labor productivity growth by 1.4 percentage points. Based on the model, we also show that temperature risk is associated with non-negligible welfare costs which amount to 18.4% of the agent's lifetime utility and grow exponentially with the size of the impact of temperature on TFP. Finally, we show that faster adaptation to temperature shocks results in lower welfare costs. These welfare benefits become substantially higher in the presence of permanent improvements in the speed of adaptation.
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).
183
Fleckenstein et al. (2014) document that nominal Treasuries trade at higher prices than inflation-swapped indexed bonds, which exactly replicate the nominal cash flows. We study whether this mispricing arises from liquidity premiums in inflation-indexed bonds (TIPS) and inflation swaps. Using US data, we show that the level of liquidity affects TIPS, whereas swap yields include a liquidity risk premium. We also allow for liquidity effects in nominal bonds. These results are based on a model with a systematic liquidity risk factor and asset-specific liquidity characteristics. We show that these liquidity (risk) premiums explain a substantial part of the TIPS underpricing.
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.
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.
191
This paper aims to analyze the effects of financial constraints and the financial crisis on the financing and investment policies of newly founded firms. Thereby, the analysis adds important new insights on a crucial segment of the economy. We make use of a large and comprehensive data set of French firms founded in the years 2004-2006, i.e. well before the financial crisis. Our panel data analysis shows that the global financial crisis imposed a shock (mostly demand-driven) on the financing as well as on the investments of these firms. Moreover, we find that financially constrained firms use less external debt financing and invest smaller amounts. They also rely on less trade credit. With regard to bank financing, newly founded firms which are more financially constrained accumulate less bank debt and repay initial bank debt slower than their non-financially constraint counterparts. Finally, we find that financially constrained firms are affected to a smaller degree by the financial crisis than their less financially constrained counterparts.
173
We develop a state-space model to decompose bid and ask quotes of CDS into two components, fair default premium and liquidity premium. This approach gives a better estimate of the default premium than mid quotes, and it allows to disentangle and compare the liquidity premium earned by the protection buyer and the protection seller. In contrast to other studies, our model is structurally much simpler, while it also allows for correlation between liquidity and default premia, as supported by empirical evidence. The model is implemented and applied to a large data set of 118 CDS for a period ranging from 2004 to 2010. The model-generated output variables are analyzed in a difference-in-difference framework to determine how the default premium, as well as the liquidity premium of protection buyers and sellers, evolved during different periods of the financial crisis and to which extent they differ for financial institutions compared to non-financials.
172
This paper examines the relationship between oil movements and systemic risk of financial institution in major petroleum-based economies. We estimate ΔCoVaR for those institutions and observe the presence of elevated increases in its levels corresponding to the subprime and global financial crises. The results provide evidence in favor of risk measurement improvements by accounting for oil returns in the risk functions. The spread between the standard CoVaR and the CoVaR that includes oil absorbs in a time range longer than the duration of the oil shock. This indicates that the drop in the oil price has a longer effect on risk and requires more time to be discounted by the financial institutions. To support the analysis, we consider also the other major market-based systemic risk measures.
179
This paper analyses the bail-in tool under the BRRD and predicts that it will not reach its policy objective. To make this argument, this paper first describes the policy rationale that calls for mandatory PSI. From this analysis the key features for an effective bail-in tool can be derived. These insights serve as the background to make the case that the European resolution framework is likely ineffective in establishing adequate market discipline through risk-reflecting prices for bank capital. The main reason for this lies in the avoidable embeddedness of the BRRD’s bail-in tool in the much broader resolution process which entails ample discretion of the authorities also in forcing private sector involvement. Finally, this paper synthesized the prior analysis by putting forward an alternative regulatory approach that seeks to disentangle private sector involvement as a precondition for effective bank-resolution as much as possible form the resolution process as such.
180
The bail-in tool as implemented in the European bank resolution framework suffers from severe shortcomings. To some extent, the regulatory framework can remedy the impediments to the desirable incentive effect of private sector involvement (PSI) that emanate from a lack of predictability of outcomes, if it compels banks to issue a sufficiently sized minimum of high-quality, easy to bail-in (subordinated) liabilities. Yet, even the limited improvements any prescription of bail-in capital can offer for PSI’s operational effectiveness seem compromised in important respects.
The main problem, echoing the general concerns voiced against the European bail-in regime, is that the specifications for minimum requirements for own funds and eligible liabilities (MREL) are also highly detailed and discretionary and thus alleviate the predicament of investors in bail-in debt, at best, only insufficiently. Quite importantly, given the character of typical MREL instruments as non-runnable long-term debt, even if investors are able to gauge the relevant risk of PSI in a bank’s failure correctly at the time of purchase, subsequent adjustment of MREL-prescriptions by competent or resolution authorities potentially change the risk profile of the pertinent instruments. Therefore, original pricing decisions may prove inadequate and so may market discipline that follows from them.
The pending European legislation aims at an implementation of the already complex specifications of the Financial Stability Board (FSB) for Total Loss Absorbing Capacity (TLAC) by very detailed and case specific amendments to both the regulatory capital and the resolution regime with an exorbitant emphasis on proportionality and technical fine-tuning. What gets lost in this approach, however, is the key policy objective of enhanced market discipline through predictable PSI: it is hardly conceivable that the pricing of MREL-instruments reflects an accurate risk-assessment of investors because of the many discretionary choices a multitude of agencies are supposed to make and revisit in the administration of the new regime. To prove this conclusion, this chapter looks in more detail at the regulatory objectives of the BRRD’s prescriptions for MREL and their implementation in the prospectively amended European supervisory and resolution framework.
176
We propose a 2-country asset-pricing model where agents' preferences change endogenously as a function of the popularity of internationally traded goods. We determine the effect of the time-variation of preferences on equity markets, consumption and portfolio choices. When agents are more sensitive to the popularity of domestic consumption goods, the local stock market reacts more strongly to the preferences of local agents than to the preferences of foreign agents. Therefore, home bias arises because home-country stock represents a better investment opportunity for hedging against future fluctuations in preferences. We test our model and find that preference evolution is a plausible driver of key macroeconomic variables and stock returns.
163
The international diffusion of technology plays a key role in stimulating global growth and explaining co-movements of international equity returns. Existing empirical evidence suggests that countries are heterogeneous in their attitude toward innovation: Some countries rely more on technology adoption while other countries rely more on internal technology production. European countries that rely more on adoption are also typically characterized by lower fiscal policy exibility and higher labor market rigidity. We develop a two-country model – where both countries rely on R&D and adoption – to study the short-run and long-run effects of aggregate technology and adoption probability shocks on economic growth in the presence of the aforementioned asymmetries. Our framework suggests that an increase in the ability to adopt technology from abroad stimulates economic growth in the country that benefits from higher adoption rates but the beneficial effects also spread to the foreign country. Moreover, it helps explaining the differences in macro quantities and equity returns observed in the international data.
169
On average young people \undersave" whereas old people \oversave" with respect to the rational expectations model of life-cycle consumption and savings. According to numerous studies on subjective survival beliefs, young people also \underestimate" whereas old people \overestimate" their objective survival chances on average. We take a structural behavioral economics approach to jointly address both empirical phenomena by embedding subjective survival beliefs that are consistent with these biases into a rank-dependent utility (RDU) model over life-cycle consumption. The resulting consumption behavior is dynamically inconsistent. Considering both naive and sophisticated RDU agents we show that within this framework underestimation of young age and overestimation of old age survival probabilities may (but need not) give rise to the joint occurrence of undersaving and oversaving. In contrast to this RDU model, the familiar quasi-hyperbolic discounting (QHD), which is nested as a special case, cannot generate oversaving.
152
The ECB’s Outright Monetary Transactions (OMT) program, launched in summer 2012, indirectly recapitalized periphery country banks through its positive impact on the value of sovereign bonds. However, the regained stability of the European banking sector has not fully transferred into economic growth. We show that zombie lending behavior of banks that still remained undercapitalized after the OMT announcement is an important reason for this development. As a result, there was no positive impact on real economic activity like employment or investment. Instead, firms mainly used the newly acquired funds to build up cash reserves. Finally, we document that creditworthy firms in industries with a high prevalence of zombie firms suffered significantly from the credit misallocation, which slowed down the economic recovery.