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229
This paper analyzes how the combination of borrowing constraints and idiosyncratic risk affects the equity premium in an overlapping generations economy. I find that introducing a zero-borrowing constraint in an economy without idiosyncratic risk increases the equity premium by 70 percent, which means that the mechanism described in Constantinides, Donaldson, and Mehra (2002) is dampened because of the large number of generations and production. With social security the effect of the zero-borrowing constraint is a lot weaker. More surprisingly, when I introduce idiosyncratic labor income risk in an economy without a zero-borrowing constraint, the equity premium increases by 50 percent, even though the income shocks are independent of aggregate risk and are not permanent. The reason is that idiosyncratic risk makes the endogenous natural borrowing limits much tighter, so that they have a similar effect to an exogenously imposed zero-borrowing constraint. This intuition is confirmed when I add idiosyncratic risk in an economy with a zero-borrowing constraint: neither the equity premium nor the Sharpe ratio change, because the zero-borrowing constraint is already tighter than the natural borrowing limits that result when idiosyncratic risk is added.
52
We study consumption-portfolio and asset pricing frameworks with recursive preferences and unspanned risk. We show that in both cases, portfolio choice and asset pricing, the value function of the investor/representative agent can be characterized by a specific semilinear partial differential equation. To date, the solution to this equation has mostly been approximated by Campbell-Shiller techniques, without addressing general issues of existence and uniqueness. We develop a novel approach that rigorously constructs the solution by a fixed point argument. We prove that under regularity conditions a solution exists and establish a fast and accurate numerical method to solve consumption-portfolio and asset pricing problems with recursive preferences and unspanned risk. Our setting is not restricted to affine asset price dynamics. Numerical examples illustrate our approach.
41
In this paper, we study the effect of proportional transaction costs on consumption-portfolio decisions and asset prices in a dynamic general equilibrium economy with a financial market that has a single-period bond and two risky stocks, one of which incurs the transaction cost. Our model has multiple investors with stochastic labor income, heterogeneous beliefs, and heterogeneous Epstein-Zin-Weil utility functions. The transaction cost gives rise to endogenous variations in liquidity. We show how equilibrium in this incomplete-markets economy can be characterized and solved for in a recursive fashion. We have three main findings. One, costs for trading a stock lead to a substantial reduction in the trading volume of that stock, but have only a small effect on the trading volume of the other stock and the bond. Two, even in the presence of stochastic labor income and heterogeneous beliefs, transaction costs have only a small effect on the consumption decisions of investors, and hence, on equity risk premia and the liquidity premium. Three, the effects of transaction costs on quantities such as the liquidity premium are overestimated in partial equilibrium relative to general equilibrium.
115
We study the life cycle of portfolio allocation following for 15 years a large random sample of Norwegian households using error-free data on all components of households’ investments drawn from the Tax Registry. Both, participation in the stock market and the portfolio share in stocks, have important life cycle patterns. Participation is limited at all ages but follows a hump-shaped profile which peaks around retirement; the share invested in stocks among the participants is high and flat for the young but investors start reducing it as retirement comes into sight. Our data suggest a double adjustment as people age: a rebalancing of the portfolio away from stocks as they approach retirement, and stock market exit after retirement. Existing calibrated life cycle models can account for the first behavior but not the second. We show that incorporating in these models a reasonable per period participation cost can generate limited participation among the young but not enough exit from the stock market among the elderly. Adding also a small probability of a large loss when investing in stocks, produces a joint pattern of participation and of the risky asset share that resembles the one observed in the data. A structural estimation of the relevant parameters that target simultaneously the portfolio, participation and asset accumulation age profiles of the model reveals that the parameter combination that fits the data best is one with a relatively large risk aversion, small participation cost and a yearly large loss probability in line with the frequency of stock market crashes in Norway.
70
We outline a procedure for consistent estimation of marginal and joint default risk in the euro area financial system. We interpret the latter risk as the intrinsic financial system fragility and derive several systemic fragility indicators for euro area banks and sovereigns, based on CDS prices. Our analysis documents that although the fragility of the euro area banking system had started to deteriorate before Lehman Brothers' file for bankruptcy, investors did not expect the crisis to affect euro area sovereigns' solvency until September 2008. Since then, and especially after November 2009, joint sovereign default risk has outpaced the rise of systemic risk within the banking system.
335
In more and more situations, artificially intelligent algorithms have to model humans’ (social) preferences on whose behalf they increasingly make decisions. They can learn these preferences through the repeated observation of human behavior in social encounters. In such a context, do individuals adjust the selfishness or prosociality of their behavior when it is common knowledge that their actions produce various externalities through the training of an algorithm? In an online experiment, we let participants’ choices in dictator games train an algorithm. Thereby, they create an externality on future decision making of an intelligent system that affects future participants. We show that individuals who are aware of the consequences of their training on the pay- offs of a future generation behave more prosocially, but only when they bear the risk of being harmed themselves by future algorithmic choices. In that case, the externality of artificially intelligence training induces a significantly higher share of egalitarian decisions in the present.
336
With Big Data, decisions made by machine learning algorithms depend on training data generated by many individuals. In an experiment, we identify the effect of varying individual responsibility for the moral choices of an artificially intelligent algorithm. Across treatments, we manipulated the sources of training data and thus the impact of each individual’s decisions on the algorithm. Diffusing such individual pivotality for algorithmic choices increased the share of selfish decisions and weakened revealed prosocial preferences. This does not result from a change in the structure of incentives. Rather, our results show that Big Data offers an excuse for selfish behavior through lower responsibility for one’s and others’ fate.
111
The pressure on tax haven countries to engage in tax information exchange shows first effects on capital markets. Empirical research suggests that investors do react to information exchange and partially withdraw from previous secrecy jurisdictions that open up to information exchange. While some of the economic literature emphasizes possible positive effects of tax havens, the present paper argues that proponents of positive effects may have started from questionable premises, in particular when it comes to the effects that tax havens have for emerging markets like China and India.
54 [v.2]
We investigate the relationship between anchoring and the emergence of bubbles in experimental asset markets. We show that setting a visual anchor at the fundamental value (FV) in the first period only is sufficient to eliminate or to significantly reduce bubbles in laboratory asset markets. If no FV-anchor is set, bubble-crash patterns emerge. Our results indicate that bubbles in laboratory environments are primarily sparked in the first period. If prices are initiated around the FV, they stay close to the FV over the entire trading horizon. Our insights can be related to initial public offerings and the interaction between prices set on pre-opening markets and subsequent intra-day price dynamics.
300
Broad, long-term financial and economic datasets are a scarce resource, in particular in the European context. In this paper, we present an approach for an extensible, i.e. adaptable to future changes in technologies and sources, data model that may constitute a basis for digitized and structured long- term, historical datasets. The data model covers specific peculiarities of historical financial and economic data and is flexible enough to reach out for data of different types (quantitative as well as qualitative) from different historical sources, hence achieving extensibility. Furthermore, based on historical German company and stock market data, we discuss a relational implementation of this approach.
49
We study the behavioral underpinnings of adopting cash versus electronic payments in retail transactions. A novel theoretical and experimental framework is developed to primarily assess the impact of sellers’ service fees and buyers’ rewards from using electronic payments. Buyers and sellers face a coordination problem, independently choosing a payment method before trading. In the experiment, sellers readily adopt electronic payments but buyers do not. Eliminating service fees or introducing rewards significantly boosts the adoption of electronic payments. Hence, buyers’ incentives play a pivotal role in the diffusion of electronic payments but monetary incentives cannot fully explain their adoption choices. Findings from this experiment complement empirical findings based on surveys and field data.
297
We relate time-varying aggregate ambiguity (V-VSTOXX) to individual investor trading. We use the trading records of more than 100,000 individual investors from a large German online brokerage from March 2010 to December 2015. We find that an increase in ambiguity is associated with increased investor activity. It also leads to a reduction in risk-taking which does not reverse over the following days. When ambiguity is high, the effect of sentiment looms larger. Survey evidence reveals that ambiguity averse investors are more prone to ambiguity shocks. Our results are robust to alternative survey-, newspaper- or market-based ambiguity measures.
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.
82
Projected demographic changes in industrialized and developing countries vary in extent and timing but will reduce the share of the population in working age everywhere. Conventional wisdom suggests that this will increase capital intensity with falling rates of return to capital and increasing wages. This decreases welfare for middle aged asset rich households. This paper takes the perspective of the three demographically oldest European nations — France, Germany and Italy — to address three important adjustment channels to dampen these detrimental effects of aging in these countries: investing abroad, endogenous human capital formation and increasing the retirement age. Our quantitative finding is that endogenous human capital formation in combination with an increase in the retirement age has strong implications for economic aggregates and welfare, in particular in the open economy. These adjustments reduce the maximum welfare losses of demographic change for households alive in 2010 by about 2.2 percentage points in terms of a consumption equivalent variation.
113
We analyze the macroeconomic implications of increasing the top marginal income tax rate using a dynamic general equilibrium framework with heterogeneous agents and a fiscal structure resembling the actual U.S. tax system. The wealth and income distributions generated by our model replicate the empirical ones. In two policy experiments, we increase the statutory top marginal tax rate from 35 to 70 percent and redistribute the additional tax revenue among households, either by decreasing all other marginal tax rates or by paying out a lump-sum transfer to all households. We find that increasing the top marginal tax rate decreases inequality in both wealth and income but also leads to a contraction of the aggregate economy. This is primarily driven by the negative effects that the tax change has on top income earners. The aggregate gain in welfare is sizable in both experiments mainly due to a higher degree of distributional equality.
No. 383
We investigate consumption patterns in Europe with supervised machine learning methods and reveal differences in age and wealth impact across countries. Using data from the third wave (2017) of the Eurosystem’s Household Finance and Consumption Survey (HFCS), we assess how age and (liquid) wealth affect the marginal propensity to consume (MPC) in the Netherlands, Germany, France, and Italy. Our regression analysis takes the specification by Christelis et al. (2019) as a starting point. Decision trees are used to suggest alternative variable splits to create categorical variables for customized regression specifications. The results suggest an impact of differing wealth distributions and retirement systems across the studied Eurozone members and are relevant to European policy makers due to joint Eurozone monetary policy and increasing supranational fiscal authority of the EU. The analysis is further substantiated by a supervised machine learning analysis using a random forest and XGBoost algorithm.
47
This paper explores consequences of consumer education on prices and welfare in retail financial markets when some consumers are naive about shrouded add-on prices and firms try to exploit it. Allowing for different information and pricing strategies we show that education is unlikely to push firms to disclose prices towards all consumers, which would be socially efficient. Instead, price discrimination emerges as a new equilibrium. Further, due to a feedback on prices, education that is good for consumers who become sophisticated may be bad for consumers who stay naive and even for the group of all consumers as a whole
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.
160
We develop a model that endogenizes the manager's choice of firm risk and of inside debt investment strategy. Our model delivers two predictions. First, managers have an incentive to reduce the correlation between inside debt and company stock in bad times. Second, managers that reduce such a correlation take on more risk in bad times. Using a sample of U.S. public firms, we provide evidence consistent with the model's predictions. Our results suggest that the weaker link between inside debt and company stock in bad times does not translate into a mitigation of debt-equity conflicts.
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.
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.
64
This paper analyzes how on-the-job search (OJS) by an agent impacts the moral hazard problem in a repeated principal-agent relationship. OJS is found to constitute a source of agency costs because efficient search incentives require that the agent receives all gains from trade. Further, the optimal incentive contract with OJS matches the design of empirically observed compensation contracts more accurately than models that ignore OJS. In particular, the optimal contract entails excessive performance pay plus efficiency wages. Efficiency wages reduce the opportunity costs of work effort and hence serve as a complement to bonuses. Thus, the model offers a novel explanation for the use of efficiency wages. When allowing for renegotiation, the model generates wage and turnover dynamics that are consistent with empirical evidence. I argue that the model contributes to explaining the concomitant rise in the use of performance pay and in competition for high-skill workers during the last three decades.
118
We build a novel leading indicator (LI) for the EU industrial production (IP). Differently from previous studies, the technique developed in this paper is able to produce an ex-ante LI that is immune to “overlapping information drawbacks”. In addition, the set of variables composing the LI relies on a dynamic and systematic criterion. This ensures that the choice of the variables is not driven by subjective views. Our LI anticipates swings (including the 2007-2008 crisis) in the EU industrial production – on average – by 2 to 3 months. The predictive power improves if the indicator is revised every five or ten years. In a forward-looking framework, via a general-to-specific procedure, we also show that our LI represents the most informative variable in approaching expectations on the EU IP growth.
360
This note argues that in a situation of an inelastic natural gas supply a restrictive monetary policy in the euro zone could reduce the energy bill and therefore has additional merits. A more hawkish monetary policy may be able to indirectly use monopsony power on the gas market. The welfare benefits of such a policy are diluted to the extent that some of the supply (approximately 10 percent) comes from within the euro zone, which may give rise to distributional concerns.
314
We focus on the role of social media as a high-frequency, unfiltered mass information transmission channel and how its use for government communication affects the aggregate stock markets. To measure this effect, we concentrate on one of the most prominent Twitter users, the 45th President of the United States, Donald J. Trump. We analyze around 1,400 of his tweets related to the US economy and classify them by topic and textual sentiment using machine learning algorithms. We investigate whether the tweets contain relevant information for financial markets, i.e. whether they affect market returns, volatility, and trading volumes. Using high-frequency data, we find that Trump’s tweets are most often a reaction to pre-existing market trends and therefore do not provide material new information that would influence prices or trading. We show that past market information can help predict Trump’s decision to tweet about the economy.
73
On average, "young" people underestimate whereas "old" people overestimate their chances to survive into the future. We adopt a Bayesian learning model of ambiguous survival beliefs which replicates these patterns. The model is embedded within a non-expected utility model of life-cycle consumption and saving. Our analysis shows that agents with ambiguous survival beliefs (i) save less than originally planned, (ii) exhibit undersaving at younger ages, and (iii) hold larger amounts of assets in old age than their rational expectations counterparts who correctly assess their survival probabilities. Our ambiguity-driven model therefore simultaneously accounts for three important empirical findings on household saving behavior.
73 [ver 2015]
Based on a cognitive notion of neo-additive capacities reflecting likelihood insensitivity with respect to survival chances, we construct a Choquet Bayesian learning model over the life-cycle that generates a motivational notion of neo-additive survival beliefs expressing ambiguity attitudes. We embed these neo-additive survival beliefs as decision weights in a Choquet expected utility life-cycle consumption model and calibrate it with data on subjective survival beliefs from the Health and Retirement Study. Our quantitative analysis shows that agents with calibrated neo-additive survival beliefs (i) save less than originally planned, (ii) exhibit undersaving at younger ages, and (iii) hold larger amounts of assets in old age than their rational expectations counterparts who correctly assess their survival chances. Our neo-additive life-cycle model can therefore simultaneously accommodate three important empirical findings on household saving behavior.
105
n the EU there are longstanding and ongoing pressures towards a tax that is levied on the EU level to substitute for national contributions. We discuss conditions under which such a transition can make sense, starting from what we call a "decentralization theorem of taxation" that is analogous to Oates (1972) famous result that in the absence of spill-over effects and economies of scale decentralized public good provision weakly dominates central provision. We then drop assumptions that turn out to be unnecessary for this results. While spill-over effects of taxation may call for central rules for taxation, as long as spill-over effects do not depend on the intra-regional distribution of the tax burden, decentralized taxation plus tax coordination is found superior to a union-wide tax.
345
This paper examines optimal enviromental policy when external financing is costly for firms. We introduce emission externalities and industry equilibrium in the Holmström and Tirole (1997) model of corporate finance. While a cap-and- trading system optimally governs both firms` abatement activities (internal emission margin) and industry size (external emission margin) when firms have sufficient internal funds, external financing constraints introduce a wedge between these two objectives. When a sector is financially constrained in the aggregate, the optimal cap is strictly above the Pigouvian benchmark and emission allowances should be allocated below market prices. When a sector is not financially constrained in the aggregate, a cap that is below the Pigiouvian benchmark optimally shifts market share to less polluting firms and, moreover, there should be no "grandfathering" of emission allowances. With financial constraints and heterogeneity across firms or sectors, a uniform policy, such as a single cap-and-trade system, is typically not optimal.
194
I present a new business cycle model in which decision making follows a simple mental process motivated by neuroeconomics. Decision makers first compute the value of two different options and then choose the option that offers the highest value, but with errors. The resulting model is highly tractable and intuitive. A demand function in level replaces the traditional Euler equation. As a result, even liquid consumers can have a large marginal propensity to consume. The interest rate affects consumption through the cost of borrowing and not through intertemporal substitution. I discuss the implications for stimulus policies.
359
We collect data on the size distribution of all U.S. corporate businesses for 100 years. We document that corporate concentration (e.g., asset share or sales share of the top 1%) has increased persistently over the past century. Rising concentration was stronger in manufacturing and mining before the 1970s, and stronger in services, retail, and wholesale after the 1970s. Furthermore, rising concentration in an industry aligns closely with investment intensity in research and development and information technology. Industries with higher increases in concentration also exhibit higher output growth. The long-run trends of rising corporate concentration indicate increasingly stronger economies of scale.
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.