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Armstrong et al. (2022) review the empirical methods used in the accounting literature to draw causal inferences. They document a growing number of studies using quasi-experimental methods and provide a critical perspective on this trend as well as the use of these methods in the accounting literature. In this discussion, I complement their review by broadening the perspective. I argue for a design-based approach to accounting research that shifts attention from methods to the entire research design. I also discuss why studies that aim to draw causal inferences are important, how these studies fit into the scientific process, and why assessing the strength of the research design is important when evaluating studies and aggregating research findings.
Financial ties between drug companies and medical researchers are thought to bias results published in medical journals. To enable readers to account for such bias, most medical journals require authors to disclose potential conflicts of interest. For such policies to be effective, conflict disclosure must modify readers’ beliefs. We therefore examine whether disclosure of financial ties with industry reduces article citations, indicating a discount. A challenge to estimating this effect is selection as drug companies may seek out higher quality authors as consultants or fund their studies, generating a positive correlation between disclosed conflicts and citations. Our analysis confirms this positive association. Including observable controls for article and author quality attenuates but does not eliminate this relation. To tease out whether other researchers discount articles with conflicts, we perform three tests. First, we show that the positive association is weaker for review articles, which are more susceptible to bias. Second, we examine article recommendations to family physicians by medical experts, who choose from articles that are a priori more homogenous in quality. Here, we find a significantly negative association between disclosure and expert recommendations, consistent with discounting. Third, we conduct an analysis within author and article, exploiting journal policy changes that result in conflict disclosure by an author. We examine the effect of this disclosure on citations to a previously published article by the same author. This analysis reveals a negative citation effect. Overall, we find evidence that disclosures negatively affect citations, consistent with the notion that other researchers discount articles with disclosed conflicts.
Speculative news on corporate takeovers may hurt productivity because uncertainty and threat of job loss cause anxiety, distraction, and reduced collaboration and morale among employees and managers. Using a panel of OECD-headquartered firms, we show that firm productivity temporarily declines upon announcements of speculative takeover rumors that do not materialize. This productivity dip is more pronounced for targets and for firms in countries with weaker employee rights and less long-term orientation. Abnormal stock returns mirror these results. The evidence fosters our understanding of potential real effects of speculative financial news and the costs of takeover threats.
Unquestionably (or: undoubtedly), every competent speaker has already come to doubt with respect to the question of which form is correct or appropriate and should be used (in the standard language) when faced with two or more almost identical competing variants of words, word forms or sentence and phrase structure (e.g. German "Pizzas/Pizzen/Pizze" 'pizzas', Dutch "de drie mooiste/mooiste drie stranden" 'the three most beautiful/most beautiful three beaches', Swedish "större än jag/mig" 'taller than I/me'). Such linguistic uncertainties or "cases of doubt" (cf. i.a. Klein 2003, 2009, 2018; Müller & Szczepaniak 2017; Schmitt, Szczepaniak & Vieregge 2019; Stark 2019 as well as the useful collections of data of Duden vol. 9, Taaladvies.net, Språkriktighetsboken etc.) systematically occur also in native speakers and they do not necessarily coincide with the difficulties of second language learners. In present-day German, most grammatical uncertainties occur in the domains of inflection (nominal plural formation, genitive singular allomorphy of strong masc./neut. nouns, inflectional variation of weak masc. nouns, strong/weak adjectival inflection and comparison forms, strong/weak verb forms, perfect auxiliary selection) and word-formation (linking elements in compounds, separability of complex verbs). As for syntax, there are often doubts in connection with case choice (pseudo-partitive constructions, prepositional case government) and agreement (especially due to coordination or appositional structures). This contribution aims to present a contrastive approach to morphological and syntactic uncertainties in contemporary Germanic languages (mostly German, Dutch, and Swedish) in order to obtain a broader and more fine-grained typology of grammatical instabilities and their causes. As will be discussed, most doubts of competent speakers - a problem also for general linguistic theory - can be attributed to processes of language change in progress, to language or variety contact, to gaps and rule conflicts in the grammar of every language or to psycholinguistic conditions of language processing. Our main concerns will be the issues of which (kinds of) common or different critical areas there are within Germanic (and, on the other hand, in which areas there are no doubts), which of the established (cross-linguistically valid) explanatory approaches apply to which phenomena and, ultimately, the question whether the new data reveals further lines of explanation for the empirically observable (standard) variation.
Climate crimes – a critique
(2023)
This paper aims on taking a critical approach to the emerging debate on climate criminal justice, that is mostly about something labeled „climate criminal law“ („Klimastrafrecht“). The critique is directed at climate crimes intended to protect our habitable climate („Klimaschutzstrafrecht“) or to prevent climate change („Klimawandelpräventionsstrafrecht“) staged as transformational criminal law. “Fighting" climate change with climate crimes can lull us into deceptive certainties and by extension into perilous idleness; and it will do so if we think of climate protection essentially in terms of traditional criminal law. Climate crimes are based on the idea that we can counter climate change with the "sharpest sword" available to a polity (cf. the German and Continental European ultima-ratio principle) and that we can thereby also get hold of "the powerful". But these certainties rest on but normative (and at heart: liberal) doctrines, which are deceptive in having lost touch with the realities of the administration of criminal justice. They obscure that more effective measures are available to mitigate the climate crisis and that "the powerful" will likely be shielded with and by climate crimes. Therefore, the climate crimes approach to the climate crisis may just turn out to be (self-)appeasement. It obfuscates that more effective measures are likely necessary to avert impending crises. Our critique is therefore not "only" directed at the symbolic, but the dysfunctional and "dark side" of climate crimes.
This paper examines the performance of 538 sovereign wealth fund (SWF) investments into venture capital, private equity, and real asset funds (“alternative asset funds”) from 52 countries around the world over the years 1995-2020. The data indicate SWFs are significantly slower to fully liquidate and earn lower returns from their investments, particularly from their investments in venture capital funds. The longer duration and lower performance of SWFs is more pronounced for strategic SWFs than savings SWFs. We show that venture capital fund investments are more likely to be in countries with lower quality disclosure indices. SWFs are more often in buyout funds, and in larger funds with a greater number of limited partners. SWF performance is enhanced by having different types of institutional investors in the same limited partnership. Overall, the data indicate sovereign wealth funds make large investments in alternative asset funds with a longer-term view and earn a lower financial return consistent with strategic and political SWF investment motives.
This paper examines the causes and consequences of hedge fund investments in exchange traded funds (ETFs) using U.S. data from 1998 to 2018. The data indicate that transient hedge funds and quasi-indexer hedge funds are substantially more likely to invest in ETFs. Unexpected hedge fund inflows cause a rise in ETF investments, and the economic significance of unexpected flow is more than twice as large for transient than quasi-indexer hedge funds. ETF investment is in general associated with lower hedge fund performance. But when ETF investment is accompanied by an increase in total flow and unexpected flow, the negative impact of ETF holdings on performance is mitigated. The data are consistent with the view that hedge fund ETF investment unrelated to unexpected flow is an agency cost of delegated portfolio management.
This paper characterizes the stationary equilibrium of a continuous-time neoclassical production economy with capital accumulation in which households can insure against idiosyncratic income risk through long-term insurance contracts. Insurance companies operating in perfectly competitive markets can commit to future contractual obligations, whereas households cannot. For the case in which household labor productivity takes two values, one of which is zero, and where households have logutility we provide a complete analytical characterization of the optimal consumption insurance contract, the stationary consumption distribution and the equilibrium aggregate capital stock and interest rate. Under parameter restrictions, there is a unique stationary equilibrium with partial consumption insurance and a stationary consumption distribution that takes a truncated Pareto form. The unique equilibrium interest rate (capital stock) is strictly decreasing (increasing) in income risk. The paper provides an analytically tractable alternative to the standard incomplete markets general equilibrium model developed in Aiyagari (1994) by retaining its physical structure, but substituting the assumed incomplete asset markets structure with one in which limits to consumption insurance emerge endogenously, as in Krueger and Uhlig (2006).
We analyze efficient risk-sharing arrangements when the value from deviating is determined endogenously by another risk sharing arrangement. Coalitions form to insure against idiosyncratic income risk. Self-enforcing contracts for both the original coalition and any coalition formed (joined) after deviations rely on a belief in future cooperation which we term "trust". We treat the contracting conditions of original and deviation coalitions symmetrically and show that higher trust tightens incentive constraints since it facilitates the formation of deviating coalitions. As a consequence, although trust facilitates the initial formation of coalitions, the extent of risk sharing in successfully formed coalitions is declining in the extent of trust and efficient allocations might feature resource burning or utility burning: trust is indeed a double-edged sword.
Employing the art-collection records of Burton and Emily Hall Tremaine, we consider whether early-stage art investors can be understood as venture capitalists. Because the Tremaines bought artists’ work very close to an artwork’s creation, with 69% of works in our study purchased within one year of the year when they were made, their collecting practice can best be framed as venture-capital investment in art. The Tremaines also illustrate art collecting as social-impact investment, owing to their combined strategy of art sales and museum donations for which the collectors received a tax credit under US rules. Because the Tremaines’ museum donations took place at a time that U.S. marginal tax rates from 70% to 91%, the near “donation parity” with markets, creating a parallel to ESG investment in the management of multiple forms of value.
Venture capital (VC) funds backed by large multi-fund families tend to perform substantially better due to cross-fund cash flows (CFCFs), a liquidity support mechanism provided by matching distributions and capital calls within a VC fund family. The dynamics of this mechanism coincide with the sensitivity of different stage projects owing to market liquidity conditions. We find that the early-stage funds demand relatively more intra-family CFCFs than later-stage funds during liquidity stress periods. We show that the liquidity improvement based on the timing of CFCF allocation reflects how fund families arrange internal liquidity provision and explains a large part of their outperformance.
Lack of privacy due to surveillance of personal data, which is becoming ubiquitous around the world, induces persistent conformity to the norms prevalent under the surveillance regime. We document this channel in a unique laboratory---the widespread surveillance of private citizens in East Germany. Exploiting localized variation in the intensity of surveillance before the fall of the Berlin Wall, we show that, at the present day, individuals who lived in high-surveillance counties are more likely to recall they were spied upon, display more conformist beliefs about society and individual interactions, and are hesitant about institutional and social change. Social conformity is accompanied by conformist economic choices: individuals in high-surveillance counties save more and are less likely to take out credit, consistent with norms of frugality. The lack of differences in risk aversion and binding financial constraints by exposure to surveillance helps to support a beliefs channel.
Supranational supervision
(2022)
We exploit the establishment of a supranational supervisor in Europe (the Single Supervisory Mechanism) to learn how the organizational design of supervisory institutions impacts the enforcement of financial regulation. Banks under supranational supervision are required to increase regulatory capital for exposures to the same firm compared to banks under the local supervisor. Local supervisors provide preferential treatment to larger institutes. The central supervisor removes such biases, which results in an overall standardized behavior. While the central supervisor treats banks more equally, we document a loss in information in banks’ risk models associated with central supervision. The tighter supervision of larger banks results in a shift of particularly risky lending activities to smaller banks. We document lower sales and employment for firms receiving most of their funding from banks that receive a tighter supervisory treatment. Overall, the central supervisor treats banks more equally but has less information about them than the local supervisor.
Industry concentration and markups in the US have been rising over the last 3-4 decades. However, the causes remain largely unknown. This paper uses machine learning on regulatory documents to construct a novel dataset on compliance costs to examine the effect of regulations on market power. The dataset is comprehensive and consists of all significant regulations at the 6-digit NAICS level from 1970-2018. We find that regulatory costs have increased by $1 trillion during this period. We document that an increase in regulatory costs results in lower (higher) sales, employment, markups, and profitability for small (large) firms. Regulation driven increase in concentration is associated with lower elasticity of entry with respect to Tobin's Q, lower productivity and investment after the late 1990s. We estimate that increased regulations can explain 31-37% of the rise in market power. Finally, we uncover the political economy of rulemaking. While large firms are opposed to regulations in general, they push for the passage of regulations that have an adverse impact on small firms.
Resolving financial distress where property rights are not clearly defined: the case of China
(2022)
We use data on financially distressed Chinese companies in order to study a debt market where property rights are crudely defined and poorly enforced. To help with identification we use an event where a business-friendly province published new guidelines regarding the administration and enforcement of assets pledged as collateral. Although by no means a comprehensive reform of bankruptcy law or property rights, by instructing courts to enforce existing, albeit rudimentary, contractual rights the new guidelines virtually eliminated creditors runs and produced a sharp increase in the survival rate of financially-distressed companies. These changes illustrate how piecemeal reforms of property rights and their enforcement may have a significant impact on economic outcomes. Our analysis and results challenge the view that a fully fledged system of private property is a precondition for economic development.
This study examines the recent literature on the expectations, beliefs and perceptions of investors who incorporate Environmental, Social, Governance (ESG) considerations in investment decisions with the aim to generate superior performance and also make a societal impact. Through the lens of equilibrium models of agents with heterogeneous tastes for ESG investments, green assets are expected to generate lower returns in the long run than their non- ESG counterparts. However, at the short run, ESG investment can outperform non-ESG investment through various channels. Empirically, results of ESG outperformance are mixed. We find consensus in the literature that some investors have ESG preference and that their actions can generate positive social impact. The shift towards more sustainable policies in firms is motivated by the increased market values and the lower cost of capital of green firms driven by investors’ choices.
This paper provides a review of the development of the non-fungible tokens (NFTs) market, with a particular focus on its pricing determinants, its current applications and future opportunities. We investigate the current state of the NFT markets and highlight the perception and expectations of investors towards these products. We summarize and compare the financial and econometric models that have been used in the literature for the pricing of non-fungible tokens with a special focus on their predictive performance. Our intention is to design a framework that can help understanding the price formation of NFTs. We further aim to shed light on the value creating determinants of NFTs in order to better understand the investors’ behavior on the blockchain.
In this article, I analyse the street market in the Osnabrück city quarter of Schinkel as a multifunctional place and an important component in the physical as well as the imaginary construction of both the immediate surroundings and the environment on a global level. Schinkel is located in the east of the city and is known as being very diverse. It is home to 14,412 inhabitants, including Poles, Portuguese, Italians, Turks, Bulgarians, and people from various countries of the former USSR as well as Germans...
Biased auctioneers
(2022)
We construct a neural network algorithm that generates price predictions for art at auction, relying on both visual and non-visual object characteristics. We find that higher automated valuations relative to auction house pre-sale estimates are associated with substantially higher price-to-estimate ratios and lower buy-in rates, pointing to estimates’ informational inefficiency. The relative contribution of machine learning is higher for artists with less dispersed and lower average prices. Furthermore, we show that auctioneers’ prediction errors are persistent both at the artist and at the auction house level, and hence directly predictable themselves using information on past errors.
This paper examines how the implementation of a new dark order - Midpoint Extended Life Order on NASDAQ - impacts financial markets stability in terms of occurrences of mini-flash crashes in individual securities. We use high-frequency order book data and apply panel regression analysis to estimate the effect of M-ELO trading on market stability and liquidity provision. The results suggest a predominance of a speed bump effect of M-ELO rather than a darkness effect. We find that the introduction of M-ELO increases market stability by reducing the average number of mini-flash crashes, but its impact on market quality is mixed.
The right to ask questions and voice their opinions at annual general meetings (AGMs) represents one of the few avenues for shareholders to communicate directly and publicly with the firm’s management. Examining AGM transcripts of U.S. companies between 2007 and 2021, we find that shareholders actively express their concerns about environmental, social and governance (ESG) issues in accordance with their specific relationship with the company. Further, they are also demonstrably more vocal about ESG issues at AGMs of firms with poor sustainability performance. What is more, we show that this soft engagement translates into a more negative tone which, in turn, results in lower approval rates for management proposals. Shareholders' soft engagement at AGMs is hence an effective way to "walk the talk".
The issuance of sustainability-linked loans (SLLs) has grown exponentially in recent years. Using a scoring methodology, we examine the underlying key performance indicators of a large sample of SLLs and analyze whether their design creates effective incentives for improving corporate sustainability performance. We demonstrate that the majority of loans fails to meet key requirements that would make them credible instruments for generating effective sustainability incentives. These findings call into question the actual sustainability impact that may be achieved through the issuance of ESG-linked debt.
Consumers purchase energy in many forms. Sometimes energy goods are consumed directly, for instance, in the form of gasoline used to operate a vehicle, electricity to light a home, or natural gas to heat a home. At other times, the cost of energy is embodied in the prices of goods and services that consumers buy, say when purchasing an airline ticket or when buying online garden furniture made from plastic to be delivered by mail. Previous research has focused on quantifying the pass-through of the price of crude oil or the price of motor gasoline to U.S. inflation. Neither approach accounts for the fact that percent changes in refined product prices need not be proportionate to the percent change in the price of oil, that not all energy is derived from oil, and that the correlation of price shocks across energy markets is far from one. This paper develops a vector autoregressive model that quantifies the joint impact of shocks to several energy prices on headline and core CPI inflation. Our analysis confirms that focusing on gasoline price shocks alone will underestimate the inflationary pressures emanating from the energy sector, but not enough to overturn the conclusion that much of the observed increase in headline inflation in 2021 and 2022 reflected non-energy price shocks.
We propose a new instrument for estimating the price elasticity of gasoline demand that exploits systematic differences across U.S. states in the pass-through of oil price shocks to retail gasoline prices. These differences, which are primarily driven by variation in the cost of producing and distributing gasoline, create cross-sectional dispersion in gasoline price growth in response to an aggregate oil price shock. We find that the elasticity was stable near -0.3 until the end of 2014, but subsequently rose to about -0.2. Our estimates inform the recent debate about gasoline-tax holidays and policies to reduce carbon emissions.
This paper investigates retirees’ optimal purchases of fixed and variable longevity income annuities using their defined contribution (DC) plan assets and given their expected Social Security benefits. As an alternative, we also evaluate using plan assets to boost Social Security benefits through delayed claiming. We determine that including deferred income annuities in DC accounts is welfare enhancing for all sex/education groups examined. We also show that providing access to well-designed variable deferred annuities with some equity exposure further enhances retiree wellbeing, compared to having access only to fixed annuities. Nevertheless, for the least educated, delaying claiming Social Security is preferred, whereas the most educated benefit more from using accumulated DC plan assets to purchase deferred annuities.
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.
Mamma mia! Revealing hidden heterogeneity by PCA-biplot : MPC puzzle for Italy's elderly poor
(2023)
I investigate consumption patterns in Italy and use a PCA-biplot to discover a consumption puzzle for the elderly poor. Data from the third wave (2017) of the Eurosystem’s Household Finance and Consumption Survey (HFCS) indicate that Italian poor old-aged households boast lower levels of the marginal propensity to consume (MPC) than suggested by the dominant consumption models. A customized regression analysis exhibits group differences with richer peers to be only half as large as prescribed by a traditional linear regression model. This analysis has benefited from a visualization technique for high-dimensional matrices related to the unsupervised machine learning literature. I demonstrate that PCA-biplots are a useful tool to reveal hidden relations and to help researchers to formulate simple research questions. The method is presented in detail and suggestions on incorporating it in the econometric modeling pipeline are given.
Fund companies regularly send shareholder letters to their investors. We use textual analysis to investigate whether these letters’ writing style influences fund flows and whether it predicts performance and investment styles. Fund investors react to the tone and content of shareholder letters: A less negative tone leads to higher net flows. Thus, fund companies can use shareholder letters as a tactical instrument to influence flows. However, at the same time, a dishonest communication that is not consistent with the fund’s actual performance decreases flows. A positive writing style predicts higher idiosyncratic risk as well as more style bets, while there is no consistent predictive power for future performance.
Optimal monetary policy studies typically rely on a single structural model and identification of model-specific rules that minimize the unconditional volatilities of inflation and real activity. In their proposed approach, the authors take a large set of structural models and look for the model-robust rules that minimize the volatilities at those frequencies that policymakers are most interested in stabilizing. Compared to the status quo approach, their results suggest that policymakers should be more restrained in their inflation responses when their aim is to stabilize inflation and output growth at specific frequencies. Additional caution is called for due to model uncertainty.
Who should hold bail-inable debt and how can regulators police holding restrictions effectively?
(2023)
This paper analyses the demand-side prerequisites for the efficient application of the bail-in tool in bank resolution, scrutinises whether the European bank crisis management and deposit insurance (CMDI) framework is apt to establish them, and proposes amendments to remedy identified shortcomings.
The first applications of the new European CMDI framework, particularly in Italy, have shown that a bail-in of debt holders is especially problematic if they are households or other types of retail investors. Such debt holders may be unable to bear losses, and the social implications of bailing them in may create incentives for decision makers to refrain from involving them in bank resolution. In turn, however, if investors can expect resolution authorities (RAs) to behave inconsistently over time and bail-out bank capital and debt holders despite earlier vows to involve them in bank rescues, the pricing and monitoring incentives that the crisis management framework seeks to invigorate would vanish. As a result, market discipline would be suboptimal and moral hazard would persist. Therefore, the policy objectives of the CMDI framework will only be achieved if critical bail-in capital is not held by retail investors without sufficient loss-bearing capacity. Currently, neither the CMDI framework nor capital market regulation suffice to assure that this precondition is met. Therefore, some amendments are necessary. In particular, debt instruments that are most likely to absorb losses in resolution should have a high minimum denomination and banks should not be allowed to self-place such securities.
The loan impairment rules recently introduced by IFRS 9 require banks to estimate their future credit losses by using forward-looking information. We use supervisory loan-level data from Germany to investigate how banks apply their reporting discretion and adjust their lending upon the announcement of the new rules. Our identification strategy exploits a cut-off for the level of provisions at the investment grade threshold based on banks’ internal rating of a borrower. We find that banks required to adopt the new rules assign better internal ratings to exactly the same borrowers compared to banks that do not apply IFRS 9 around this cut-off. This pattern is consistent with a strategic use of the increased reporting discretion that is inherent to rules requiring forward-looking loss estimation. At the same time, banks also reduce their lending exposure to exactly those borrowers at the highest risk of experiencing a rating downgrade below the cutoff. These loans would be associated with additional provisions in future periods, both in the intensive and extensive margin. The lending change thus mitigates some of the negative effects of increased reporting opportunism on banks’ crisis resilience. However, when these firms with internal ratings around the investment grade cut-off obtain less external funding through banks, the introduction of IFRS 9 will likely also be associated with real economic effects
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.
Recent empirical evidence shows that most international prices are sticky in dollars. This paper studies the policy implications of this fact in the context of an open economy model, allowing for an arbitrary structure of asset markets, general preferences and technologies, time- or state-dependent price setting, and a rich set of shocks. We show that although monetary policy is less efficient and cannot implement the flexible-price allocation, inflation targeting remains robustly optimal in non-U.S. economies. The implementation of this non-cooperative policy results in a "global monetary cycle" with other countries importing the monetary stance of the U.S. The capital controls cannot unilaterally improve the allocation and are useful only when coordinated across countries. Thanks to the dominance of the dollar, the U.S. can extract rents in international goods and asset markets and enjoy a higher welfare than other economies. Although international cooperation benefits other countries by improving global demand for dollar-invoiced goods, it is not in the self-interest of the U.S. and may be hard to sustain.
Output gap revisions can be large even after many years. Real-time reliability tests might therefore be sensitive to the choice of the final output gap vintage that the real-time estimates are compared to. This is the case for the Federal Reserve’s output gap. When accounting for revisions in response to the global financial crisis in the final output gap, the improvement in real-time reliability since the mid-1990s is much smaller than found by Edge and Rudd (Review of Economics and Statistics, 2016, 98(4), 785-791). The negative bias of real-time estimates from the 1980s has disappeared, but the size of revisions continues to be as large as the output gap itself.
The authors systematically analyse how the realtime reliability assessment is affected through varying the final output gap vintage. They find that the largest changes are caused by output gap revisions after recessions. Economists revise their models in response to such events, leading to economically important revisions not only for the most recent years, but reaching back up to two decades. This might improve the understanding of past business cycle dynamics, but decreases the reliability of real-time output gaps ex post.
The great financial crisis and the euro area crisis led to a substantial reform of financial safety nets across Europe and – critically – to the introduction of supranational elements. Specifically, a supranational supervisor was established for the euro area, with discrete arrangements for supervisory competences and tasks depending on the systemic relevance of supervised credit institutions. A resolution mechanism was created to allow the frictionless resolution of large financial institutions. This resolution mechanism has been now complemented with a funding instrument.
While much more progress has been achieved than most observers could imagine 12 years ago, the banking union remains unfinished with important gaps and deficiencies. The experience over the past years, especially in the area of crisis management and resolution, has provided impetus for reform discussions, as reflected most lately in the Eurogroup statement of 16 June 2022.
This Policy Insight looks primarily at the current and the desired state of the banking union project. The key underlying question, and the focus here, is the level of ambition and how it is matched with effective legal and regulatory tools. Specifically, two questions will structure the discussions:
What would be a reasonable definition and rationale for a ‘complete’ banking union? And what legal reforms would be required to achieve it?
Banking union is a case of a new remit of EU-level policy that so far has been established on the basis of long pre-existing treaty stipulations, namely, Article 127(6) TFEU (for banking supervision) and Article 114 TFEU (for crisis management and deposit insurance). Could its completion be similarly carried out through secondary law? Or would a more comprehensive overhaul of the legal architecture be required to ensure legal certainty and legitimacy?
Using the negotiation process of the Basel Committee on Banking Supervision (BCBS), this paper studies the way regulators form their positions on regulatory issues in the process of international standard-setting and the consequences on the resultant harmonized framework. Leveraging on leaked voting records and corroborating them using machine learning techniques on publicly available speeches, we construct a unique dataset containing the positions of banks and national regulators on the regulatory initiatives of Basel II and III. We document that the probability of a regulator opposing a specific initiative increases by 30% if their domestic national champion opposes the new rule, particularly when the proposed rule disproportionately affects them. We find the effect is driven by regulators who had prior experience of working in large banks – lending support to the private-interest theories of regulation. Meanwhile smaller banks, even when they collectively have a higher share in the domestic market, do not have any impact on regulators’ stand – providing little support to public-interest theories of regulation. Finally, we show this decision-making process manifests into significant watering down of proposed rules, thereby limiting the potential gains from harmonization of international financial regulation.
The financial sector plays an important role in financing the green transformation. Various regulatory initiatives in the EU aim to improve transparency in relation to the sustainability of financial products and the sustainability of economic activities of non-financial and financial undertakings. For credit institutions, the Green Asset Ratio (GAR) has been established by the European regulatory authorities as a KPI for measuring the proportion of Taxonomy-aligned on-balance-sheet exposure in relation to the total assets. The breakdown of the total GAR by type of counterparty, environmental objective and type of asset provides in-depth information about the sustainability profile of a credit institution. This information, which has not been available to date, may also initiate discussions between management and shareholders or other stakeholders regarding the future sustainability strategy of credit institutions. This paper provides an overview of the regulatory background and the method of calculating the GAR along different dimensions. Finally, the potential benefits and limitations of the GAR are discussed.
Highly interconnected global supply chains make countries vulnerable to supply chain disruptions. The authors estimate the macroeconomic effects of global supply chain shocks for the euro area. Their empirical model combines business cycle variables with data from international container trade.
Using a novel identification scheme, they augment conventional sign restrictions on the impulse responses by narrative information about three episodes: the Tohoku earthquake in 2011, the Suez Canal obstruction in 2021, and the Shanghai backlog in 2022. They show that a global supply chain shock causes a drop in euro area real economic activity and a strong increase in consumer prices. Over a horizon of one year, the global supply chain shock explains about 30% of inflation dynamics. They also use regional data on supply chain pressure to isolate shocks originating in China.
Their results show that supply chain disruptions originating in China are an important driver for unexpected movements in industrial production, while disruptions originating outside China are an especially important driver for the dynamics of consumer prices.
The author proposes a Differential-Independence Mixture Ensemble (DIME) sampler for the Bayesian estimation of macroeconomic models.It allows sampling from particularly challenging, high-dimensional black-box posterior distributions which may also be computationally expensive to evaluate. DIME is a “Swiss Army knife”, combining the advantages of a broad class of gradient-free global multi-start optimizers with the properties of a Monte Carlo Markov chain (MCMC). This includes fast burn-in and convergence absent any prior numerical optimization or initial guesses, good performance for multimodal distributions, a large number of chains (the “ensemble”) running in parallel, an endogenous proposal density generated from the state of the full ensemble, which respects the bounds of the prior distribution. The author shows that the number of parallel chains scales well with the number of necessary ensemble iterations.
DIME is used to estimate the medium-scale heterogeneous agent New Keynesian (“HANK”) model with liquid and illiquid assets, thereby for the first time allowing to also include the households’ preference parameters. The results mildly point towards a less accentuated role of household heterogeneity for the empirical macroeconomic dynamics.
The authors estimate perceptions about the Fed's monetary policy rule from panel data on professional forecasts of interest rates and macroeconomic conditions. The perceived dependence of the federal funds rate on economic conditions is time-varying and cyclical: high during tightening episodes but low during easings. Forecasters update their perceptions about the policy rule in response to monetary policy actions, measured by high-frequency interest rate surprises, suggesting that forecasters have imperfect information about the rule. The perceived rule impacts asset prices crucial for monetary policy transmission, driving how interest rates respond to macroeconomic news and explaining term premia in long-term interest rates.
We employ a proprietary transaction-level dataset in Germany to examine how capital requirements affect the liquidity of corporate bonds. Using the 2011 European Banking Authority capital exercise that mandated certain banks to increase regulatory capital, we find that affected banks reduce their inventory holdings, pre-arrange more trades, and have smaller average trade size. While non-bank affiliated dealers increase their market-making activity, they are unable to bridge this gap - aggregate liquidity declines. Our results are stronger for banks with a higher capital shortfall, for non-investment grade bonds, and for bonds where the affected banks were the dominant market-maker.
We develop a two-sector incomplete markets integrated assessment model to analyze the effectiveness of green quantitative easing (QE) in complementing fiscal policies for climate change mitigation. We model green QE through an outstanding stock of private assets held by a monetary authority and its portfolio allocation between a clean and a dirty sector of production. Green QE leads to a partial crowding out of private capital in the green sector and to a modest reduction of the global temperature by 0.04 degrees of Celsius until 2100. A moderate global carbon tax of 50 USD per tonne of carbon is 4 times more effective.
Many people do not understand the concepts of life expectancy and longevity risk, potentially leading them to under-save for retirement or to not purchase longevity insurance, which in turn could reduce wellbeing at older ages. We investigate alternative ways to increase the salience of both concepts, allowing us to assess whether these change peoples’ perceptions and financial decision making. Using randomly-assigned vignettes providing subjects with information about either life expectancy or longevity, we show that merely prompting people to think about financial decisions changes their perceptions regarding subjective survival probabilities. Moreover, this information also boosts respondents’ interest in saving and demand for longevity insurance. In particular, longevity information influences both subjective survival probabilities and financial decisions, while life expectancy information influences only annuity choices. We provide some evidence that many people are simply unaware of longevity risk.
When the COVID-19 crisis struck, banks using internal-rating based (IRB) models quickly recognized the increase in risk and reduced lending more than banks using a standardized approach. This effect is not driven by borrowers’ quality or by banks in countries with credit booms before the pandemic. The higher risk sensitivity of IRB models does not always result in lower credit provision when risk intensifies. Certain features of the IRB models – the use of a downturn Loss Given Default parameter – can increase banks’ resilience and preserve their intermediation capacity also during downturns. Affected borrowers were not able to fully insulate and decreased corporate investments.
Previous studies document a relationship between gambling activity at the aggregate level and investments in securities with lottery-like features. We combine data on individual gambling consumption with portfolio holdings and trading records to examine whether gambling and trading act as substitutes or complements. We find that gamblers are more likely than the average investor to hold lottery stocks, but significantly less likely than active traders who do not gamble. Our results suggest that gambling behavior across domains is less relevant compared to other portfolio characteristics that predict investing in high-risk and high-skew securities, and that gambling on and off the stock market act as substitutes to satisfy the same need, e.g., sensation seeking.
Colocation services offered by stock exchanges enable market participants to achieve execution costs for large orders that are substantially lower and less sensitive to transacting against high-frequency traders. However, these benefits manifest only for orders executed on the colocated brokers' own behalf, whereas customers' order execution costs are substantially higher. Analyses of individual order executions indicate that customer orders originating from colocated brokers are less actively monitored and achieve inferior execution quality. This suggests that brokers do not make effective use of their technology, possibly due to agency frictions or poor algorithm selection and parameter choice by customers.
The leading premium
(2022)
In this paper, we consider conditional measures of lead-lag relationships between aggregate growth and industry-level cash-flow growth in the US. Our results show that firms in leading industries pay an average annualized return 3.6\% higher than that of firms in lagging industries. Using both time series and cross sectional tests, we estimate an annual pure timing premium ranging from 1.2% to 1.7%. This finding can be rationalized in a model in which (a) agents price growth news shocks, and (b) leading industries provide valuable resolution of uncertainty about the growth prospects of lagging industries.
Advances in Machine Learning (ML) led organizations to increasingly implement predictive decision aids intended to improve employees’ decision-making performance. While such systems improve organizational efficiency in many contexts, they might be a double-edged sword when there is the danger of a system discontinuance. Following cognitive theories, the provision of ML-based predictions can adversely affect the development of decision-making skills that come to light when people lose access to the system. The purpose of this study is to put this assertion to the test. Using a novel experiment specifically tailored to deal with organizational obstacles and endogeneity concerns, we show that the initial provision of ML decision aids can latently prevent the development of decision-making skills which later becomes apparent when the system gets discontinued. We also find that the degree to which individuals 'blindly' trust observed predictions determines the ultimate performance drop in the post-discontinuance phase. Our results suggest that making it clear to people that ML decision aids are imperfect can have its benefits especially if there is a reasonable danger of (temporary) system discontinuances.
Search costs for lenders when evaluating potential borrowers are driven by the quality of the underwriting model and by access to data. Both have undergone radical change over the last years, due to the advent of big data and machine learning. For some, this holds the promise of inclusion and better access to finance. Invisible prime applicants perform better under AI than under traditional metrics. Broader data and more refined models help to detect them without triggering prohibitive costs. However, not all applicants profit to the same extent. Historic training data shape algorithms, biases distort results, and data as well as model quality are not always assured. Against this background, an intense debate over algorithmic discrimination has developed. This paper takes a first step towards developing principles of fair lending in the age of AI. It submits that there are fundamental difficulties in fitting algorithmic discrimination into the traditional regime of anti-discrimination laws. Received doctrine with its focus on causation is in many cases ill-equipped to deal with algorithmic decision-making under both, disparate treatment, and disparate impact doctrine. The paper concludes with a suggestion to reorient the discussion and with the attempt to outline contours of fair lending law in the age of AI.
Many nations incentivize retirement saving by letting workers defer taxes on pension contributions, imposing them when retirees withdraw their funds. Using a dynamic life cycle model, we show how ‘Rothification’ – that is, taxing 401(k) contributions rather than payouts – alters saving, investment, consumption, and Social Security claiming patterns. We find that taxing pension contributions instead of withdrawals leads to delayed retirement, somewhat lower lifetime tax payments, and relatively small reductions in consumption. Indeed, the two tax regimes generate quite similar relative inequality metrics: the relative consumption inequality ratio under TEE is only four percent higher than in the EET case. Moreover, results indicate that the Gini measures are also strikingly similar under the EET and the TEE regimes for lifetime consumption, cash on hand, and 401(k) assets, differing by only 1-4 percent. While tax payments are higher early in life under the TEE regime, they are slightly lower in the long run. Moreover, higher EET tax payments are also accompanied by higher volatility. We therefore find few reasons for policymakers to favor either tax approach on egalitarian or revenue-enhancing grounds.
We analyze how market fragmentation affects market quality of SME and other less actively traded stocks. Compared to large stocks, they are less likely to be traded on multiple venues and show, if at all, low levels of fragmentation. Concerning the impact of fragmentation on market quality, we find evidence for a hockey stick effect: Fragmentation has no effect for infrequently traded stocks, a negative effect on liquidity of slightly more active stocks, and increasing benefits for liquidity of large and actively traded stocks. Consequently, being traded on multiple venues is not necessarily harmful for SME stock market quality.
The authors propose a new method to forecast macroeconomic variables that combines two existing approaches to mixed-frequency data in DSGE models. The first existing approach estimates the DSGE model in a quarterly frequency and uses higher frequency auxiliary data only for forecasting. The second method transforms a quarterly state space into a monthly frequency. Their algorithm combines the advantages of these two existing approaches.They compare the new method with the existing methods using simulated data and real-world data. With simulated data, the new method outperforms all other methods, including forecasts from the standard quarterly model. With real world data, incorporating auxiliary variables as in their method substantially decreases forecasting errors for recessions, but casting the model in a monthly frequency delivers better forecasts in normal times.
Search costs for lenders when evaluating potential borrowers are driven by the quality of the underwriting model and by access to data. Both have undergone radical change over the last years, due to the advent of big data and machine learning. For some, this holds the promise of inclusion and better access to finance. Invisible prime applicants perform better under AI than under traditional metrics. Broader data and more refined models help to detect them without triggering prohibitive costs. However, not all applicants profit to the same extent. Historic training data shape algorithms, biases distort results, and data as well as model quality are not always assured. Against this background, an intense debate over algorithmic discrimination has developed. This paper takes a first step towards developing principles of fair lending in the age of AI. It submits that there are fundamental difficulties in fitting algorithmic discrimination into the traditional regime of anti-discrimination laws. Received doctrine with its focus on causation is in many cases ill-equipped to deal with algorithmic decision-making under both, disparate treatment, and disparate impact doctrine. The paper concludes with a suggestion to reorient the discussion and with the attempt to outline contours of fair lending law in the age of AI.
We investigate the impact of uneven transparency regulation across countries and industries on the location of economic activity. Using two distinct sources of regulatory variation—the varying extent of financial-reporting requirements and the staggered introduction of electronic business registers in Europe—, we consistently document that direct exposure to transparency regulation is negatively associated with the focal industry’s economic activity in terms of inputs (e.g., employment) and outputs (e.g., production). By contrast, we find that indirect exposure to supplier and customer industries’ transparency regulation is positively associated with the focal industry’s economic activity. Our evidence suggests uneven transparency regulation can reallocate economic activity from regulated toward unregulated countries and industries, distorting the location of economic activity.
To ensure the credibility of market discipline induced by bail-in, neither retail investors nor peer banks should appear prominently among the investor base of banks’ loss absorbing capital. Empirical evidence on bank-level data provided by the German Federal Financial Supervisory Authority raises a few red flags. Our list of policy recommendations encompasses disclosure policy, data sharing among supervisors, information transparency on holdings of bail-inable debt for all stakeholders, threshold values, and a well-defined upper limit for any bail-in activity. This document was provided by the Economic Governance Support Unit at the request of the ECON Committee.
European banks have substantial investments in assets that are
measured without directly observable market prices (mark-to-
model). Financial disclosures of these value estimates lack
standardization and are hard to compare across banks. These
comparability concerns are concentrated in large European
banks that extensively rely on level 3 estimates with the most
unobservable inputs. Although the relevant balance sheet
positions only represent a small fraction of these large banks’
total assets (2.9%), their value equals a significant fraction of core
equity tier 1 (48.9%). Incorrect valuations thus have a potential to
impact financial stability. 85% of these bank assets are under
direct ECB supervision. Prudential regulation requires value
adjustments that are apt to shield capital against valuation risk.
Yet, stringent enforcement is critical for achieving this objective.
This document was provided by the Economic Governance
Support Unit at the request of the ECON Committee.
Linear rational-expectations models (LREMs) are conventionally "forwardly" estimated as follows. Structural coefficients are restricted by economic restrictions in terms of deep parameters. For given deep parameters, structural equations are solved for "rational-expectations solution" (RES) equations that determine endogenous variables. For given vector autoregressive (VAR) equations that determine exogenous variables, RES equations reduce to reduced-form VAR equations for endogenous variables with exogenous variables (VARX). The combined endogenous-VARX and exogenous-VAR equations comprise the reduced-form overall VAR (OVAR) equations of all variables in a LREM. The sequence of specified, solved, and combined equations defines a mapping from deep parameters to OVAR coefficients that is used to forwardly estimate a LREM in terms of deep parameters. Forwardly-estimated deep parameters determine forwardly-estimated RES equations that Lucas (1976) advocated for making policy predictions in his critique of policy predictions made with reduced-form equations.
Sims (1980) called economic identifying restrictions on deep parameters of forwardly-estimated LREMs "incredible", because he considered in-sample fits of forwardly-estimated OVAR equations inadequate and out-of-sample policy predictions of forwardly-estimated RES equations inaccurate. Sims (1980, 1986) instead advocated directly estimating OVAR equations restricted by statistical shrinkage restrictions and directly using the directly-estimated OVAR equations to make policy predictions. However, if assumed or predicted out-of-sample policy variables in directly-made policy predictions differ significantly from in-sample values, then, the out-of-sample policy predictions won't satisfy Lucas's critique.
If directly-estimated OVAR equations are reduced-form equations of underlying RES and LREM-structural equations, then, identification 2 derived in the paper can linearly "inversely" estimate the underlying RES equations from the directly-estimated OVAR equations and the inversely-estimated RES equations can be used to make policy predictions that satisfy Lucas's critique. If Sims considered directly-estimated OVAR equations to fit in-sample data adequately (credibly) and their inversely-estimated RES equations to make accurate (credible) out-of-sample policy predictions, then, he should consider the inversely-estimated RES equations to be credible. Thus, inversely-estimated RES equations by identification 2 can reconcile Lucas's advocacy for making policy predictions with RES equations and Sims's advocacy for directly estimating OVAR equations.
The paper also derives identification 1 of structural coefficients from RES coefficients that contributes mainly by showing that directly estimated reduced-form OVAR equations can have underlying LREM-structural equations.
Short sale bans may improve market quality during crises: new evidence from the 2020 Covid crash
(2022)
In theory, banning short selling stabilizes stock prices but undermines pricing efficiency and has ambiguous impacts on market liquidity. Empirical studies find mixed and conflicting results. This paper leverages cross-country policy variation during the 2020 Covid crisis to assess differential impacts of bans on stock liquidity, prices, and volatility. Results suggest that bans improved liquidity and stabilized prices for illiquid stocks but temporarily diminished liquidity for highly liquid stocks.The findings support theories in which short sale bans may improve liquidity by selectively filtering out informed— potentially predatory—traders. Thus, policies that target the most illiquid stocks may deliver better overall market quality than uniform short sale bans imposed on all stocks.
With open banking, consumers take greater control over their own financial data and share it at their discretion. Using a rich set of loan application data from the largest German FinTech lender in consumer credit, this paper studies what characterizes borrowers who share data and assesses its impact on loan application outcomes. I show that riskier borrowers share data more readily, which subsequently leads to an increase in the probability of loan approval and a reduction in interest rates. The effects hold across all credit risk profiles but are the most pronounced for borrowers with lower credit scores (a higher increase in loan approval rate) and higher credit scores (a larger reduction in interest rate). I also find that standard variables used in credit scoring explain substantially less variation in loan application outcomes when customers share data. Overall, these findings suggest that open banking improves financial inclusion, and also provide policy implications for regulators engaged in the adoption or extension of open banking policies.
With free delivery of products virtually being a standard in E-commerce, product returns pose a major challenge for online retailers and society. For retailers, product returns involve significant transportation, labor, disposal, and administrative costs. From a societal perspective, product returns contribute to greenhouse gas emissions and packaging disposal and are often a waste of natural resources. Therefore, reducing product returns has become a key challenge. This paper develops and validates a novel smart green nudging approach to tackle the problem of product returns during customers’ online shopping processes. We combine a green nudge with a novel data enrichment strategy and a modern causal machine learning method. We first run a large-scale randomized field experiment in the online shop of a German fashion retailer to test the efficacy of a novel green nudge. Subsequently, we fuse the data from about 50,000 customers with publicly-available aggregate data to create what we call enriched digital footprints and train a causal machine learning system capable of optimizing the administration of the green nudge. We report two main findings: First, our field study shows that the large-scale deployment of a simple, low-cost green nudge can significantly reduce product returns while increasing retailer profits. Second, we show how a causal machine learning system trained on the enriched digital footprint can amplify the effectiveness of the green nudge by “smartly” administering it only to certain types of customers. Overall, this paper demonstrates how combining a low-cost marketing instrument, a privacy-preserving data enrichment strategy, and a causal machine learning method can create a win-win situation from both an environmental and economic perspective by simultaneously reducing product returns and increasing retailers’ profits.
Financial literacy affects wealth accumulation, and pension planning plays a key role in this relationship. In a large field experiment, we employ a digital pension aggregation tool to confront a treatment group with a simplified overview of their current pension claims across all pillars of the pension system. We combine survey and administrative bank data to measure the effects on actual saving behavior. Access to the tool decreases pension uncertainty for treated individuals. Average savings increase - especially for the financially less literate. We conclude that simplification of pension information can potentially reduce disparities in pension planning and savings behavior.
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.
This paper challenges widespread assumptions in trust research according to which trust and conflict are opposing terms or where trust is generally seen as a value. Rather, it argues that trust is only valuable if properly justified, and it places such justifications in contexts of social and political conflict. For these purposes, the paper suggests a distinction between a general concept and various conceptions of trust, and it defines the concept as a four-place one. With regard to the justification of trust, a distinction between internal and full justification is introduced, and the justification of trust is linked to relations of justification between trusters and trusted. Finally, trust in conflict(s) emerges were such relations exist among the parties of a conflict, often by way of institutional mediation.
The pion multiplicity per participating nucleon in central nucleus-nucleus collisions at the energies 2-15 A GeV is significantly smaller than in nucleon-nucleon interactions at the same collision energy. This effect of pion suppression is argued to appear due to the evolution of the system produced at the early stage of heavy-ion collisions towards a local thermodynamic equilibrium and further isentropic expansion.
Rapidity distributions of net hyperons (Λ−Λ¯¯¯¯) are compared to distributions of participant protons (p−p¯¯¯). Strangeness production (mean multiplicities of produced Λ/Σ0 hyperons and ⟨K+K¯¯¯¯¯⟩) in central nucleus-nucleus collisions is shown for different collision systems at different energies. An enhanced production of Λ¯¯¯¯ compared to p¯¯¯ is observed at 200 GeV per nucleon.
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.
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.
The authors present and compare Newton-based methods from the applied mathematics literature for solving the matrix quadratic that underlies the recursive solution of linear DSGE models. The methods are compared using nearly 100 different models from the Macroeconomic Model Data Base (MMB) and different parameterizations of the monetary policy rule in the medium-scale New Keynesian model of Smets and Wouters (2007) iteratively. They find that Newton-based methods compare favorably in solving DSGE models, providing higher accuracy as measured by the forward error of the solution at a comparable computation burden. The methods, however, suffer from their inability to guarantee convergence to a particular, e.g. unique stable, solution, but their iterative procedures lend themselves to refining solutions either from different methods or parameterizations.
Liquidity derivatives
(2022)
It is well established that investors price market liquidity risk. Yet, there exists no financial claim contingent on liquidity. We propose a contract to hedge uncertainty over future transaction costs, detailing potential buyers and sellers. Introducing liquidity derivatives in Brunnermeier and Pedersen (2009) improves financial stability by mitigating liquidity spirals. We simulate liquidity option prices for a panel of NYSE stocks spanning 2000 to 2020 by fitting a stochastic process to their bid-ask spreads. These contracts reduce the exposure to liquidity factors. Their prices provide a novel illiquidity measure refllecting cross-sectional commonalities. Finally, stock returns significantly spread along simulated prices.
In the communication of the European Central Bank (ECB), the statement that „we act within our mandate“ is often referred to. Also among practitioners of the Eurosystem the term „mandate“ has become popular. In his Working Paper, Helmut Siekmann analyzes the legal foundation of the tasks and objectives of the Eurosysstem and price stability as a legal term. He finds that the primary law of the EU only very sparsely employs the term „mandate“. It is never used in the context of monetary policy and its institutions. Moreover, he comes to the conclusion that inflation targeting as a task, competence, or objective of the Eurosystem is legally highly questionable according to the common standards of interpretation.
Identifying the cause of discrimination is crucial to design effective policies and to understand discrimination dynamics. Building on traditional models, this paper introduces a new explanation for discrimination: discrimination based on motivated reasoning. By systematically acquiring and processing information, individuals form motivated beliefs and consequentially discriminate based on these beliefs. Through a series of experiments, I show the existence of discrimination based on motivated reasoning and demonstrate important differences to statistical discrimination and taste-based discrimination. Finally, I demonstrate how this form of discrimination can be alleviated by limiting individuals’ scope to interpret information.
Spillovers of PE investments
(2022)
In this paper, we investigate a primary potential impact of leveraged buyout (LBOs) transactions: the effects of LBOs on the peers of the LBO target in the same industry. Using a data sample based on US LBO transactions between 1985 and 2016, we investigate the impact of the peer firms in the aftermath of the transaction, relative to non-peer firms. To account for potential endogeneity concerns, we employ a network-based instrumental variable approach. Based on this analysis, we find support for the proposition that LBOs do indeed matter for peer firms’ performance and corporate strategy relative to non-peer firms. Our study supports a learning factor hypothesis: peers gain by learning from the LBO target to improve their operational performance. Conversely, we find no evidence to support the conjecture that peers lose due to the increased competitiveness of the LBO target firm.
The authors study the effects of forward looking communication in an environment of rising inflation rates on German consumers‘ inflation expectations using a randomized control trial. They show that information about rising inflation increases short- and long-term inflation expectations. This initial increase in expectations can be mitigated using forward looking information about inflation. Among these information treatments, professional forecasters‘ projections seem to reduce inflation expectations by more than policymakers‘ characterization of inflation as a temporary phenomenon.
The reuse of collateral can support the efficient allocation of safe assets in the financial system. Exploiting a novel dataset, we show that banks substantially increase their reuse of sovereign bonds in response to scarcity induced by Eurosystem asset purchases. While repo rates react little to purchase-induced scarcity when reuse is low, they become increasingly sensitive at high levels of reuse. An elevated reuse rate is also associated with more failures to deliver and a higher volatility of repo rates in the cross-section of bonds. Our results highlight the trade-off between shock absorption and shock amplification effects of collateral reuse.
Common ownership and the (non-)transparency of institutional shareholdings: an EU-US comparison
(2022)
This paper compares the extent of common ownership in the US and the EU stock markets, with a particular focus on differences in the ap- plicable ownership transparency requirements. Most empirical research on common ownership to date has focused on US issuers, largely relying on ownership data obtained from institutional investors’ 13F filings. This type of data is generally not available for EU issuers. Absent 13F filings, researchers have to use ownership records sourced from mutual funds’ periodic reports and blockholder disclosures. Constructing a “reduced dataset” that seeks to capture only ownership information available for both EU and US issuers, I demonstrate that the “extra” ownership information introduced by 13F filings is substantial. However, even when taking differences in the transparency situation into due account, common ownership among listed EU firms is much less pronounced than among listed US firms by any measure. This is true even if the analysis is limited to non-controlled firms.
Peer effects can lead to better financial outcomes or help propagate financial mistakes across social networks. Using unique data on peer relationships and portfolio composition, we show considerable overlap in investment portfolios when an investor recommends their brokerage to a peer. We argue that this is strong evidence of peer effects and show that peer effects lead to better portfolio quality. Peers become more likely to invest in funds when their recommenders also invest, improving portfolio diversification compared to the average investor and various placebo counterfactuals. Our evidence suggests that social networks can provide good advice in settings where individuals are personally connected.
Cryptocurrencies provide a unique opportunity to identify how derivatives impact spot markets. They are fully fungible, trade across multiple spot exchanges at different prices, and futures contracts were selectively introduced on bitcoin (BTC) exchange rates against the USD in December 2017. Following the futures introduction, we find a significantly greater increase in cross-exchange price synchronicity for BTC--USD relative to other exchange rate pairs, as demonstrated by an increase in price correlations and a reduction in arbitrage opportunities and volatility. We also find support for an increase in price efficiency, market quality, and liquidity. The evidence suggests that futures contracts allowed investors to circumvent trading frictions associated with short sale constraints, arbitrage risk associated with block confirmation time, and market segmentation. Overall, our analysis supports the view that the introduction of BTC--USD futures was beneficial to the bitcoin spot market by making the underlying prices more informative.
he ECB is independent, but it is also accountable to the European parliament (EP). Yet, how the EP has held the ECB accountable has largely been overlooked. This paper starts addressing this gap by providing descriptive statistics of three accountability modalities. The paper highlights three findings. First, topics of accountability have changed. Climate-related accountability has increased quickly and dramatically since 2017. Second, if the relationship between price stability and climate change remains an object of conflict among MEPs, a majority within the EP has emerged to put pressure for the ECB to take a more active stance against climate change, precisely on behalf of its price stability mandate. Third, MEPs engage with the climate topic in very specific ways. There is a gender divide between the climate and the price stability topics. Women engage more actively with climate-related topics. While the Greens heavily dominate the climate topic, parties from the Right dominate the topic of Price stability. Finally, MEPs adopt a more united strategy and a particularly low confrontational tone in their climate-related interventions.
Veronika Grimm, Lukas Nöh, and Volker Wieland assess the possible development of government interest expenditures as a share of GDP for Germany, France, Italy and Spain. Until 2021, these and other member states could anticipate a further reduction of interest expenditure in the future. This outlook has changed considerably with the recent surge in inflation and government bond rates. Nevertheless, under reasonable assumptions current yield curves still imply that interest expenditure relative to GDP can be stabilized at the current level. The authors also review the implications of a further upward shift in the yield curves of 1 or 2 percentage points. These implications suggest significant medium-term risks for highly indebted member states with interest expenditure approaching or exceeding levels last observed on the eve of the euro area debt crisis. In light of these risks, governments of euro area member states should take substantive action to achieve a sustained decline in debt-to-GDP ratios towards safer levels. They bear the responsibility for making sure that government finances can weather the higher interest rates which are required to achieve price stability in the euro area.
Central banks have faced a succession of crises over the past years as well as a number of structural factors such as a transition to a greener economy, demographic developments, digitalisation and possibly increased onshoring. These suggest that the future inflation environment will be different from the one we know. Thus uncertainty about important macroeconomic variables and, in particular, inflation dynamics will likely remain high.
Global consensus is growing on the contribution that corporations and finance must make towards the net-zero transition in line with the Paris Agreement goals. However, most efforts in legislative instruments as well as shareholder or stakeholder initiatives have ultimately focused on public companies.
This article argues that such a focus falls short of providing a comprehensive approach to the problem of climate change. In doing so, it examines the contribution of private companies to climate change, the relevance of climate risks for them, as well as the phenomenon of brown-spinning (ie, the practice of public companies selling their highly polluting assets to private companies). We show that one cannot afford to ignore private companies in the net-zero transition and climate change adaptation. Yet, private companies lack several disciplining mechanisms that are available to public companies, such as institutional investor engagement, certain corporate governance arrangements, and transparency through regular disclosure obligations. At this stage, only some generic regulatory instruments such as carbon pricing and environmental regulation apply to them.
The article closes with a discussion of the main policy implications. Primarily, we discuss and evaluate the recent push to extend climate-related disclosure requirements to private companies. These disclosures would not only help investors by addressing information asymmetry, but also serve a wide group of stakeholders and thus aim at promoting a transition to a greener economy.
The authors study the impact of dissent in the ECB‘s Governing Council on uncertainty surrounding households‘ inflation expectations. They conduct a randomized controlled trial using the Bundesbank Online Panel Households. Participants are provided with alternative information treatments concerning the vote in the Council, e.g. unanimity and dissent, and are asked to submit probabilistic inflation expectations. The results show that the vote is informative.
Households revise their subjective inflation forecast after receiving information about the vote. Dissenting votes cause a wider individual distribution of future inflation. Hence, dissent increases households‘ uncertainty about inflation. This effect is statistically significant once the authors allow for the interaction between the treatments and individual characteristics of respondents.
The results are robust with respect to alternative measures of forecast uncertainty and hold for different model specifications. The findings suggest that providing information about dissenting votes without additional information about the nature of dissent is detrimental to coordinating household expectations.
We provide the first comprehensive analysis of option information for pricing the cross-section of stock returns by jointly examining extensive sets of firm and option characteristics. Using portfolio sorts and high-dimensional methods, we show that certain option measures have significant predictive power, even after controlling for firm characteristics, earning a Fama-French three-factor alpha in excess of 20% per annum. Our analysis further reveals that the strongest option characteristics are associated with information about asset mispricing and future tail return realizations. Our findings are consistent with models of informed trading and limits to arbitrage.
The transition to a sustainable economy currently involves a fundamental transformation of our capital markets. Lawmakers, in an attempt to overcome this challenge, frequently seek to prescribe and regulate how firms may address environmental, social, and governance (ESG) concerns by formulating conduct standards. Deviating from this conceptual starting point, the present paper makes the case for another path towards achieving greater sustainability in capital markets, namely through the empowerment of investors.
This trust in the market itself is grounded in various recent developments both on the supply side and the demand side of financial markets, and also in the increasing tendency of institutional investors to engage in common ownership. The need to build coalitions among different types of asset managers or institutional investors, and to convince fellow investors of a given initiative, can then act as an in-built filter helping to overcome the pursuit of idiosyncratic motives and supporting only those campaigns that are seconded by a majority of investors. In particular, institutionalized investor platforms have emerged over recent years as a force for investor empowerment, serving to coordinate investor campaigns and to share the costs of engagement.
ESG engagement has the potential to become a very powerful driver towards a more sustainability-oriented future. Indeed, I show that investor-led sustainability has many advantages compared to a more prescriptive, regulatory approach where legislatures are in the driver’s seat. For example, a focus on investor-led priorities would follow a more flexible and dynamic pattern rather than complying with inflexible pre-defined criteria. Moreover, investor-promoted assessments are not likely to impair welfare creation in the same way as ill-defined legal standards; they will also not trigger regulatory arbitrage and would avoid deadlock situations in corporate decision-making. Any regulatory activity should then be limited to a facilitative and supportive role.
This paper studies the interactions between corporate law and VC exits by acquisitions, an increasingly common source of VC-related litigation. We find that transactions by VC funds under liquidity pressure are characterized by (i) a substantially lower sale price; (ii) a greater probability of industry outsiders as acquirers; (iii) a positive abnormal return for acquirers. These features indicate the existence of fire sales, which satisfy VCs' liquidation preferences but hurt common shareholders, leaving board members with conflicting fiduciary duties and litigation risks. Exploiting an important court ruling that establishes the board’s fiduciary duties to common shareholders as a priority, we find that after the ruling maturing VCs become less likely to exit by fire sales and they distribute cash to their investors less timely. However, VCs experience more difficult fundraising ex-ante, highlighting the potential cost of a common-favoring regime. Overall the evidence has important implications for optimal fiduciary duty design in VC-backed start-ups.
We estimate the cost of cultural biases in high-stake economic decisions by comparing agents’ peer-to-peer lending choices with those the same agents make under the assistance of an automated robo-advisor. We first confirm substantial in-group vs. out-group and stereotypical discrimination, which are stronger for lenders who reside where historical cultural biases are higher. We then exploit our unique setting to document that cultural biases are costly: agents face 8% higher default rates on favored-group borrowers when unassisted. The returns they earn on favored groups increase by 7.3 percentage points when assisted. The high riskiness of the marginal borrowers from favorite groups largely explains the bad performance of culturally-biased choices. Because varying economic incentives do not reduce agents’ biases, inaccurate statistical discrimination—unconscious biased beliefs about borrowers’ quality—can explain our results better than taste-based discrimination.
The European Central Bank (ECB) recently proclaimed a more active role for itself in the fight against climate change. Did the European Parliament (EP) play a part in this regard, and if so what was it? To answer this question, this paper builds on a multi-method text analysis of original datasets compiling communications between the ECB and the EP across three accountability forums between 2014 and 2021. The paper shows that there has been discursive convergence between central bankers and parliamentarians concerning the role of the ECB in combatting climate change. It argues that this convergence has resulted from a pragmatic (yet precarious) adoption of a common repertoire1 between ‘green’ central bankers and parliamentarians who have favored a more active role for the ECB in the fight against climate change. The adoption of a common repertoire is pragmatic, in that it results from the strategic use of specific discursive elements that are ambitious enough to address their respective opponents and trigger political change, yet vague enough to allow both sets of actors to converge on them momentarily. It is also precarious in the sense that it involves discarding fundamental political tensions, which is hardly tenable in the long term. The paper shows that both organizational and politicization dynamics have been at work in the emergence of this pragmatic yet precarious bedfellowship between ‘green’ central bankers and parliamentarians.
Trust between parties should drive contract design: if parties were suspicious about each others’ reaction to unplanned events, they might agree to pay higher costs of negotiation ex ante to complete contracts. Using a unique sample of U.S. consulting contracts and a negative shock to trust between shareholders/managers (principals) and consultants (agents) staggered across space and over time, we find that lower trust increases contract completeness. Not only the complexity but also the verifiable states of the world covered by contracts increase after trust drops. The results hold for several novel text-analysis-based measures of contract completeness and do not arise in falsification tests. At the clause level, we find that non-compete agreements, confidentiality, indemnification, and termination rules are the most likely clauses added to contracts after a negative shock to trust and these additions are not driven by new boilerplate contract templates. These clauses are those whose presence should be sensitive to the mutual trust between principals and agents.
Large technology firms («BigTechs») increasingly extend their influence in finance, primarily taking over market shares in payment services. A further expansion of their businesses into the territory of cryptocurrencies could entail new and unprecedented risks for the future, namely for financial stability, competition in the private sector and monetary policy. When creating a regulatory toolbox to address these risks, financial regulatory, antitrust, and platform-specific solutions should be closely intertwined in order to fully absorb all the potential threats and to take account of the complex risks these platform companies bear. This policy letter evaluates the solutions lately proposed by the European Commission, with specific focus on the upcoming regulation of Markets in crypto-assets (MiCA), but also the Digital Markets Act (DMA) and Digital services act (DSA), against the background of cryptocurrencies issued by BigTechs and sheds light on financial regulatory, competition and monetary law issues coming along with the possible designs of these cryptocurrencies.
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.
We investigate what statistical properties drive risk-taking in a large set of observational panel data on online poker games (n=4,450,585). Each observation refers to a choice between a safe 'insurance' option and a binary lottery of winning or losing the game. Our setting offers a real-world choice situation with substantial incentives where probability distributions are simple, transparent, and known to the individuals. We find that individuals reveal a strong and robust preference for skewness. The effect of skewness is most pronounced among experienced and losing players but remains highly significant for winning players, in contrast to the variance effect.
The authors focus on the stabilizing role of cash from a society-wide perspective. Starting with conceptual remarks on the importance of money for the economy in general, special attention is paid to the unique characteristics of cash. As these become apparent especially during crisis periods, a comparison of the Great Depression (1929 – 1933) and the Great Recession 2008/09 shows the devastating effects of a severe monetary contraction and how a fully elastic provision of cash can help to avoid such a situation.
The authors find interesting similarities to both crises in two separate case studies, one on the demonetization in India 2016 and the other on cash supply during various crises in Greece since 2008. The paper concludes that supply-driven cash withdrawals from circulation (either by demonetization or by capital controls) destabilize the economy if electronic payment substitutes are not instantly available.
However, as there is no perfect substitute for cash due to its unique properties, from the viewpoint of the society as a whole an efficient payment mix necessarily includes cash: It helps to stabilize the economy not only in times of crises in general, no matter which government is in place. The authors argue that it should be the undisputed task of central banks to ensure that cash remains in circulation in normal times and is provided in a fully elastic way in times of crisis.
In this publication, researchers from the social and economic sciences and medicine as well as practitioners from the media and politics reflect on the influence of scientific expertise in times of crisis. Differences and similarities between the Covid-19 pandemic, the financial and economic crisis, the refugee crisis and the climate crisis are elaborated. The interviews were conducted in November/December 2021.
The sixth sanction package of the European Union in the context of the aggression against Ukraine excludes Sberbank, the largest Russian bank, from the SWIFT network. The increasing use of SWIFT as a tool for sanctions stimulates the rollout of alternative payment information systems by the governments of Russia and China. This policy white paper informs about the alternatives at hand, as well as their advantages and disadvantages. Careful reflection about these issues is particularly important, given the call for an “Economic Article 5” tabled for the next NATO meeting. Finally, the white paper highlights the need for institutional reforms, if policymakers decide to return SWIFT to the status of a global public good after the war.
This work uses financial markets connected by arbitrage relations to investigate the dynamics of price and liquidity discovery, which refer to the cross-instrument forecasting power for prices and liquidity, respectively. Specifically, we seek to understand the linkage between the cheapest to deliver bond and closest futures pairs by using high-frequency data on European governments obligations and derivatives. We split the 2019-2021 sample into three subperiods to appreciate changes in the liquidity discovery induced by the COVID-19 pandemic. Within a cointegration model, we find that price discovery occurs on the futures market, and document strong empirical support for liquidity spillovers both from the futures to the cash market as well as from the cash to the futures market.
Despite the impressive success of deep neural networks in many application areas, neural network models have so far not been widely adopted in the context of volatility forecasting. In this work, we aim to bridge the conceptual gap between established time series approaches, such as the Heterogeneous Autoregressive (HAR) model (Corsi, 2009), and state-of-the-art deep neural network models. The newly introduced HARNet is based on a hierarchy of dilated convolutional layers, which facilitates an exponential growth of the receptive field of the model in the number of model parameters. HARNets allow for an explicit initialization scheme such that before optimization, a HARNet yields identical predictions as the respective baseline HAR model. Particularly when considering the QLIKE error as a loss function, we find that this approach significantly stabilizes the optimization of HARNets. We evaluate the performance of HARNets with respect to three different stock market indexes. Based on this evaluation, we formulate clear guidelines for the optimization of HARNets and show that HARNets can substantially improve upon the forecasting accuracy of their respective HAR baseline models. In a qualitative analysis of the filter weights learnt by a HARNet, we report clear patterns regarding the predictive power of past information. Among information from the previous week, yesterday and the day before, yesterday's volatility makes by far the most contribution to today's realized volatility forecast. Moroever, within the previous month, the importance of single weeks diminishes almost linearly when moving further into the past.
For the academic audience, this paper presents the outcome of a well-identified, large change in the monetary policy rule from the lens of a standard New Keynesian model and asks whether the model properly captures the effects. For policymakers, it presents a cautionary tale of the dismal effects of ignoring basic macroeconomics. The Turkish monetary policy experiment of the past decade, stemming from a belief of the government that higher interest rates cause higher inflation, provides an unfortunately clean exogenous variance in the policy rule. The mandate to keep rates low, and the frequent policymaker turnover orchestrated by the government to enforce this, led to the Taylor principle not being satisfied and eventually a negative coeffcient on inflation in the policy rule. In such an environment, was the exchange rate still a random walk? Was inflation anchored? Does the “standard model”” suffice to explain the broad contours of macroeconomic outcomes in an emerging economy with large identifying variance in the policy rule? There are no surprises for students of open-economy macroeconomics; the answers are no, no, and yes.
Why bank money creation?
(2022)
We provide a rationale for bank money creation in our current monetary system by investigating its merits over a system with banks as intermediaries of loanable funds. The latter system could result when CBDCs are introduced. In the loanable funds system, households limit banks’ leverage ratios when providing deposits to make sure they have enough “skin in the game” to opt for loan monitoring. When there is unobservable heterogeneity among banks with regard to their (opportunity) costs from monitoring, aggregate lending to bank-dependent firms is inefficiently low. A monetary system with bank money creation alleviates this problem, as banks can initiate lending by creating bank deposits without relying on household funding. With a suitable regulatory leverage constraint, the gains from higher lending by banks with a high repayment pledgeability outweigh losses from banks which are less diligent in monitoring. Bank-risk assessments, combined with appropriate risk-sensitive capital requirements, can reduce or even eliminate such losses.
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.
We investigate the link between Big Five personality traits and the marginal propensity to consume (MPC) for users of a German financial account aggregator app. We use 1,700 survey responses and transaction data of 56,000 app users to assess whether Big Five personality traits help explain MPC heterogeneity. We find that extraversion corresponds to an increase in consumption whereas agreeableness and neuroticism correspond to a decrease in consumption. We test this with trust and risk preferences and find that risk indicates more explanatory power in consumption response than the Big Five. Our findings help policy makers target individuals more efficiently.