Finance and Economics Discussion Series
Abstract: Despite the extensive attention that the Basel capital adequacy standards have received internationally, significant variation exists in the implementation of these standards across countries. Furthermore, a significant number of countries increase or decrease the stringency of capital regulations over time. The paper investigates the empirical determinants of the variation in the data based on the theories of bank capital regulation. The results show that countries with high average returns to investment and a high ratio of government ownership of banks choose less stringent capital regulation standards. Capital regulations may also be less stringent in countries with more concentrated banking sectors.
Keywords: Basel capital accord, Capital requirements, Financial regulation, international policy coordination
Abstract: I provide empirical evidence that the effect of high-cost credit access on household material well-being depends on if a household is experiencing temporary financial distress. Using detailed data on household consumption and location, as well as geographic variation in access to high-cost payday loans over time, I find that payday credit access improves well-being for households in distress by helping them smooth consumption. In periods of temporary financial distress--after extreme weather events like hurricanes and blizzards--I find that payday loan access mitigates declines in spending on food, mortgage payments, and home repairs. In an average period, however, I find that access to payday credit reduces well-being. Loan access reduces spending on nondurable goods overall and reduces housing- and food-related spending particularly. These results highlight the state-dependent nature of the effects of high-cost credit as well as the consumption-smoothing role that it plays for households with limited access to other forms of credit.
Keywords: Consumer credit, Consumption, Household finance, Payday loans
David Aikman, Andreas Lehnert, Nellie Liang, and Michele Modugno
Abstract: We define a measure to be a financial vulnerability if, in a VAR framework that allows for nonlinearities, an impulse to the measure leads to an economic contraction. We evaluate alternative macrofinancial imbalances as vulnerabilities: nonfinancial sector credit, risk appetite of financial market participants, and the leverage and short-term funding of financial firms. We find that nonfinancial credit is a vulnerability: impulses to the credit-to-GDP gap when it is high leads to a recession. Risk appetite leads to an economic expansion in the near-term, but also higher credit and a recession in later years, suggesting an intertemporal tradeoff. Monetary policy is generally ineffective at slowing the economy once the credit-to-GDP gap is high, suggesting important benefits from avoiding excessive credit growth. Financial sector leverage and short-term funding do not lead directly to contractions and thus are not vulnerabilities by our definition.
Keywords: Financial stability and risk, credit, monetary policy
Stéphane Moyen, Nikolai Stähler, and Fabian Winkler
Abstract: We discuss how cross-country unemployment insurance can be used to improve international risk sharing. We use a two-country business cycle model with incomplete financial markets and frictional labor markets where the unemployment insurance scheme operates across both countries. Cross-country insurance through the unemployment insurance system can be achieved without affecting unemployment outcomes. The Ramsey-optimal policy however prescribes a more countercyclical replacement rate when international risk sharing concerns enter the unemployment insurance trade-off. We calibrate our model to Eurozone data and find that optimal stabilizing transfers through the unemployment insurance system are sizable and mainly stabilize consumption in the periphery countries, while optimal replacement rates are countercylical overall. Moreover, we find that debt-financed national policies are a poor substitute for fiscal transfers.
Keywords: Fiscal Union, International Business Cycles, International Risk Sharing, Unemployment Insurance
Lindsay Jacobs and Suphanit Piyapromdee
Abstract: Partial and reverse retirement are two key behaviors characterizing labor force dynamics for individuals at older ages, with half working part-time and over a third leaving and later re-entering the labor force. The high rate of exit and re-entry is especially surprising given the declining wage profile at older ages and opportunities for re-entry in the future being uncertain. In this paper we study the effects of wage and health transition processes as well as the role of accrues work-related strain on the labor force participation on older males. We find that a model incorporating a work burnout-recovery process can account for such reverse retirement behavior that cannot be generated by health and wealth shocks alone, suggesting re-entry patterns result in large part from planned behavior. We first present descriptive statistics of the frequency and timing of re-entry and characteristics of those who re-enter using Health and Retirement Study (HRS) panel data. We then develop and estimate a dynamic model of retirement that captures the occurrence and timing of re-entry decisions observed in the data--as well as the transition to part-time work--while incorporating uncertainty in earnings, health, and stress accumulation. The burnout-recovery process allows us to account of for about 40 percent of re-entry, and one-quarter of the shifts to part-time work with age. We also consider the lower exit and re-entry rates after 2008, and attribute this to high option values of work in an environment where future re-entry is less certain. Consistent with out burnout-recovery model, we see that respondents are more likely to report high levels of job stress as they continue to work when they would have otherwise stopped working, recovered, and re-entered. This offers us some information about the relative option value of work versus the burnout-recovery process.
Keywords: labor supply, retirement
Abstract: This paper shows that funding liquidity risk is priced in the cross-section of excess returns on agency mortgage-backed securities (MBS). We derive a measure of funding liquidity risk from dollar-roll implied financing rates (IFRs), which reflect security-level costs of financing positions in the MBS market. We show that factors representing higher net MBS supply are generally associated with higher IFRs, or higher funding costs. In addition, we find that exposure to systematic funding liquidity shocks embedded in the IFRs is compensated in the cross-section of expected excess returns--agency MBS that are better hedges to funding liquidity shocks on average deliver lower excess returns--and that these premiums are separate from the premiums associated with prepayment risks.
Keywords: Agency mortgage-backed securities, Dollar rolls, Expected returns, Implied financing rates, Large Scale Asset Purchase programs, Liquidity
Abstract: There is much variation in the physical requirements across occupations, giving rise to great differences in later-life productivity, disability risk, and the value of Social Security Disability Insurance (SSDI). In this paper, I look at how such differences across occupations affect initial career choice as well as the extent to which SSDI, which insures shocks to productivity due to disability, prompts more people to choose physically intense occupations. Using data from the Health and Retirement Study (HRS) and the Current Population Survey (CPS), I estimate a dynamic model of occupational choice and retirement with heterogeneous agents and equilibrium effects on earnings across occupations. I document the differences between blue-collar and white-collar occupations in the effects of declining health and disability on productivity, which affects labor supply in later life and, in the context of a life-cycle model, influences the occupation decision. Thro ugh counterfactual exercises, I show that the additional disability risk in blue-collar jobs relative to white-collar jobs is equivalent to an additional six percentage point reduction in lifetime consumption and that the absence of SSDI, which insures some of this risk, would be equivalent to, respectively, a twelve and seven percent reduction in consumption for those in blue- and white-collar jobs. Furthermore, I find that the presence of SSDI results in three percent more individuals choosing blue-collar occupations, which is comparable to the effect on occupation selection resulting from an eight-percent increase in blue-collar earnings. This overall effect, however, masks the importance of the selection of less risk-averse individuals into blue-collar jobs and the equilibrium effects on wages; earnings for the most risk-averse type would have to be nearly fifteen percent greater to choose blue-collar occupations in the absence of SSDI.
Keywords: Disability, life-cycle modeling, occupational choice, retirement
Abstract: The existing literature implicitly or explicitly assumes that securities lenders primarily respond to demand from borrowers and reinvest their cash collateral through short-term markets. Using a new dataset that matches every U.S. life insurer's bond portfolio, as well as their lending and reinvestment decisions, to the universe of securities lending transactions, we offer compelling evidence for an alternative strategy, in which securities lending programs are used to finance a portfolio of long-dated assets. We discuss how the liquidity and maturity mismatch associated with using securities lending as a source of wholesale funding could potentially impair the functioning of the securities market.
Keywords: Life insurers, market liquidity, securities lending, wholesale funding
Abstract: This paper studies the interaction between monetary policy, financial markets, and the real economy. We develop a Bayesian framework to estimate proxy structural vector autoregressions (SVARs) in which monetary policy shocks are identified by exploiting the information contained in high frequency data. For the Great Moderation period, we find that monetary policy shocks are key drivers of fluctuations in industrial output and corporate credit spreads, explaining about 20 percent of the volatility of these variables. Central to this result is a systematic component of monetary policy characterized by a direct and economically significant reaction to changes in credit spreads. We show that the failure to account for this endogenous reaction induces an attenuation bias in the response of all variables to monetary shocks.
Keywords: Bayesian Inference, Monetary policy, Vector Autoregressions
Steven L. Heston and Nitish R. Sinha
Abstract: This paper uses a dataset of more than 900,000 news stories to test whether news can predict stock returns. We measure sentiment with a proprietary Thomson-Reuters neural network. We find that daily news predicts stock returns for only 1 to 2 days, confirming previous research. Weekly news, however, predicts stock returns for one quarter. Positive news stories increase stock returns quickly, but negative stories have a long delayed reaction. Much of the delayed response to news occurs around the subsequent earnings announcement.
Keywords: News, Text Analysis
Abstract: Motor vehicle dealerships in the United States tend to hold inventories equivalent to around 65 days' worth of sales, a relatively high level that has been nearly unchanged for 50 years. Despite playing a prominent role in the volatility of U.S. business cycles, very little is known about why the auto industry targets inventory stocks at such a high level. We use a panel of inventory and sales data from 41 vehicle brands over 30 years and the solutions to two well-known inventory planning problems to show that vehicle inventories appear to be related to (1) the size of dealership franchise networks, which tend to be large; (2) product variety, which tends to be high; and (3) the volatility of new vehicle sales, which also tends to be high. We show that differences across brands in these variables explain a good bit of the cross-section dispersion in brand inventory-sales ratios. Offsetting changes in these factors over time also help explain why the industry's overall inventory-sales ratio has been quite flat for many decades. More recently, the net increase observed in the inventory-sales ratio in the past couple of years is in contrast to fit of the model, which might suggest that some of that increase could reverse in the coming years.
Keywords: Inventories, Motor Vehicles
Abstract: One potential consequence of rising concentration of income at the top of the distribution is increased borrowing, as less affluent households attempt to maintain standards of living with less income. This paper explores the "keeping up with the Joneses" phenomenon using data from the Survey of Consumer Finances. Specifically, it examines the responsiveness of payment-to-income ratios for different debt types at different parts of the income distribution to changes in the income thresholds at the 95th and 99th percentiles. The analysis provides some evidence indicating that household debt payments are responsive to rising top incomes. Middle and upper-middle income households take on more housing-related debt and have higher housing debt payment to income ratios in places with higher top income levels. Among households at the bottom of the income distribution there is a decline in non-mortgage borrowing and debt payments in areas with rising top-income levels, consistent with restrictions in the supply of credit. The analysis also consistently shows that 95th percentile income has a greater influence on borrowing and debt payment across in the rest of the distribution than the more affluent 99th percentile level.
Keywords: Consumption, Debt, Inequality
Robert J. Kurtzman and David Zeke
Abstract: This paper presents accounting decompositions of changes in aggregate labor and capital productivity. Our simplest decomposition breaks changes in an aggregate productivity ratio into two components: A mean component, which captures common changes to firm factor productivity ratios, and a dispersion component, which captures changes in the variance and higher order moments of their distribution. In standard models with heterogeneous firms and frictions to firm input decisions, the dispersion component is a function of changes in the second and higher moments of the log of marginal revenue factor productivities and reflects changes in the extent of distortions to firm factor input allocations across firms. We apply our decomposition to public firm data from the United States and Japan. We find that the mean component is responsible for most of the variation in aggregate productivity over the business cycle, while the dispersion component plays a modest role.
Keywords: Accounting Decomposition, Business Cycles, Misallocation, Productivity
Michele Modugno, Bariş Soybilgen, and Ege Yazgan
Abstract: Real gross domestic product (GDP) data in Turkey are released with a very long delay compared with other economies, between 10 and 13 weeks after the end of the reference quarter. To infer the current state of the economy, policy makers, media, and market practitioners examine data that are more timely, that are released at higher frequencies than the GDP. In this paper, we propose an econometric model that automatically allows us to read through these more current and higher-frequency data and translate them into nowcasts for the Turkish real GDP. Our model outperforms nowcasts produced by the Central Bank of Turkey, the International Monetary Fund, and the Organization for Economic Co-operation and Development. Moreover, our model allows us to quantify the importance of each variable in our dataset in nowcasting Turkish real GDP. In line with findings for other economies, we find that real variables play the most important role; however, contrary to the findings for other economies, we find that financial variables are as important as surveys.
Keywords: Developing economy, dynamic factor model, emerging market, gross domestic product, news, nowcasting
Francois Gourio, Todd Messer, and Michael Siemer
Abstract: Using an annual panel of US states over the period 1982-2014, we estimate the response of macroeconomic variables to a shock to the number of new firms (startups). We find that these shocks have significant effects that persist for many years on real GDP, productivity, and population. This is consistent with simple models of firm dynamics where a "missing generation" of firms affects productivity persistently.
Keywords: Productivity, business dynamics, employment, firm entry, missing generation, new business formation
May 2016 (revised June 2016)
Credit Default Swaps in General Equilibrium: Spillovers, Credit Spreads, and Endogenous Default (PDF)
R. Matthew Darst and Ehraz Refayet
Abstract: This paper highlights two new effects of credit default swap markets (CDS) in a general equilibrium setting. First, when firms' cash flows are correlated, CDSs impact the cost of capital–credit spreads–and investment for all firms, even those that are not CDS reference entities. Second, when firms internalize the credit spread changes, the incentive to issue safe rather than risky bonds is fundamentally altered. Issuing safe debt requires a transfer of profits from good states to bad states to ensure full repayment. Alternatively, issuing risky bonds maximizes profits in good states at the expense of default in bad states. Profits fall when credit spreads increase, which raises the opportunity cost of issuing risky debt compared to issuing safe debt. Symmetrically, lower credit spreads reduce the opportunity cost of issuing risky debt relative to safe debt. CDSs affect the credit spread at which firms issue risky debt, and ultimately the opportunity cost of issuing defa ultable bonds even when underlying firm fundamentals remain unchanged. Hedging (Speculating on) credit risk lowers (raises) credit spreads and enlarges (reduces) the parameter region over which firms choose to issue risky debt.
Keywords: Credit derivatives, default risk, investment, spillovers
Original DOI: http://dx.doi.org/10.17016/FEDS.2016.042
Cecilia R. Caglio, Kathleen Weiss Hanley, and Jennifer Marietta-Westberg
Abstract: This paper examines which firms benefit the most from going public abroad and how a robust IPO market affects the trend toward greater globalization of capital. We show that the decision to do an IPO outside the home country is affected not only by the home country's market characteristics but also the extent to which it is financially integrated with the world economy. In addition, we provide evidence that the decisions of whether to go public abroad, where to list, and the amount of proceeds raised are determined by the presence of global underwriters. Our results suggest that the rise of global underwriters facilitates the movement of capital across nations and is one of the channels by which world globalization can affect the IPO process.
Keywords: IPO, globalization, proceeds, underwriter
Minchul Shin and Molin Zhong
Abstract: This paper proposes a multivariate stochastic volatility-in-vector autoregression model called the conditional autoregressive inverse Wishart-in-VAR (CAIW-in-VAR) model as a framework for studying the real effects of uncertainty shocks. We make three contributions to the literature. First, the uncertainty shocks we analyze are estimated directly from macroeconomic data so they are associated with changes in the volatility of the shocks hitting the macroeconomy. Second, we advance a new approach to identify uncertainty shocks by placing limited economic restrictions on the first and second moment responses to these shocks. Third, we consider an extension of the sign restrictions methodology of Uhlig (2005) to uncertainty shocks. To illustrate our methods, we ask what is the role of financial markets in transmitting uncertainty shocks to the real economy? We find evidence that an increase in uncertainty leads to a decline in industrial production only if associated with a deterioration in financial conditions.
Keywords: Multivariate stochastic volatility, Uncertainty, Vector autoregression, Volatility-in-mean, Wishart process
Yi Che, Yi Lu, Justin R. Pierce, Peter K. Schott, and Zhigang Tao
Abstract: This paper examines the impact of trade liberalization on U.S. Congressional elections. We find that U.S. counties subject to greater competition from China via a change in U.S. trade policy exhibit relative increases in turnout, the share of votes cast for Democrats and the probability that the county is represented by a Democrat. We find that these changes are consistent with Democrats in office being more likely than Republicans to support legislation limiting import competition or favoring economic assistance.
Keywords: China, Elections, Import Competition, Normal Trade Relations, Voting, World Trade Organization
Stephie Fried, Kevin Novan, and William B. Peterman
Abstract: This paper examines the non-environmental welfare effects of introducing a revenue-neutral carbon tax policy. Using a life cycle model, we find that the welfare effects of the policy differ substantially for agents who are alive when the policy is enacted compared to those who are born into the new steady state with the carbon tax in place. Consistent with previous studies, we demonstrate that, for those born in the new steady state, the welfare costs are always lower when the carbon tax revenue is used to reduce an existing distortionary tax as opposed to being returned in the form of lump-sum payments. In contrast, during the transition, we find that rebating the revenue with a lump sum transfer is less costly than using the revenue to reduce the distortionary labor tax. Additionally, we find that the tax policy is substantially more regressive over the transition than in the steady state, regardless of what is done with the revenue. Overall, our results demonstrate that estimates of the non-environmental welfare costs of carbon tax policies that are based solely on the long-run, steady state outcomes may ultimately paint too rosy of a picture. Thus, when designing climate policies, policymakers must pay careful attention to not only the long-run outcomes, but also the transitional welfare costs and regressivity of the policy.
Keywords: Carbon taxation, overlapping generations
Jeffrey R. Gerlach and Youngsuk Yook
Abstract: We examine the response of foreign investors to escalating political conflict and its impact on the South Korean stock market surrounding 13 North Korean military attacks between 1999 and 2010. Using domestic institutions and domestic individuals as benchmarks, we evaluate the trading behavior and performance of foreign investors. Following attacks, foreigners increase their holdings of Korean stocks and buy more shares of risky stocks. Performance results show foreigners maintain their pre-attack level of performance while domestic individuals, who make the overwhelming majority of domestic trades, perform worse. In addition, domestic institutions improve their performance. Overall, the results are consistent with the predictions based on the benefits of international diversification. Unlike domestic individuals, foreigners trade more shares than usual and deviate from their general strategy of positive feedback trading.
Keywords: Foreign portfolio investment, North Korean attacks, Political conflict
Daniela Bragoli and Michele Modugno
Abstract: We propose a dynamic factor model for nowcasting the growth rate of quarterly real Canadian gross domestic product. We show that the proposed model produces more accurate nowcasts than those produced by institutional forecasters, like the Bank of Canada, the The Organisation for Economic Co-operation and Development (OECD), and the survey collected by Bloomberg, which reflects the median forecast of market participants. We show that including U.S. data in a nowcasting model for Canada dramatically improves its predictive accuracy, mainly because of the absence of timely production data for Canada. Moreover, Statistics Canada produces a monthly real GDP measure along with the quarterly one, and we show how to modify the state space representation of our model to properly link the monthly GDP with its quarterly counterpart.
Keywords: Dynamic Factor Model, Nowcasting, Updating
Abstract: This paper examines two candidate hypotheses explaining the stabilization of U.S. inflation since the 1970s and 1980s. The first explanation credits the stabilization of inflation expectations, and assumes those expectations have a strong positive causal effect on actual subsequent inflation, while the second explanation credits the disappearance of such a strong positive causal effect. The paper reports statistical tests favorable to both a stabilization of inflation expectations and a marked decline in the effect of the general public's inflation expectations on subsequent inflation.
Keywords: Inflation, Phillips Curve
Albert S. Kyle, Anna A. Obizhaeva, and Tugkan Tuzun
Abstract: This paper studies invariance relationships in tick-by-tick transaction data in the U.S. stock market. Over the period 1993-2001, the estimated monthly regression coefficients of the log of trade arrival rate on the log of trading activity have an almost constant value of 0.666, strikingly close to the value of 2/3 predicted by invariance hypothesis. Over the period 2001-2014, the estimated coefficients rise, and their average value is equal to 0.79, suggesting that the reduction in tick size in 2001 and subsequent increase in algorithmic trading resulted in a more intense order shredding in more liquid stocks. The distributions of trade sizes, adjusted for differences in trading activity, resemble a log-normal before 2001; there are clearly visible truncation at the round-lot boundary and clustering of trades at even-levels. These distributions change dramatically over the period 2001-2014 with their means shifting downwards. The invariance hypothesis explains about 88% of the cross-sectional variation in trade arrival rates and average trade sizes; additional explanatory variables include invariance-implied measure of effective price volatility.
Keywords: TAQ data, market frictions, market microstructure, order shredding, tick size, trade size, transactions data
Abstract: Modeling interest rates over samples that include the Great Recession requires taking stock of the effective lower bound (ELB) on nominal interest rates. We propose a flexible time--series approach which includes a "shadow rate''---a notional rate that is less than the ELB during the period in which the bound is binding---without imposing no--arbitrage assumptions. The approach allows us to estimate the behavior of trend real rates as well as expected future interest rates in recent years.
Keywords: Bayesian Econometrics, Effective Lower Bound, Shadow Rate, State-Space Model, Term Structure of Interest Rates
Alex Hsu, Erica X.N. Li, and Francisco Palomino
Abstract: The links between real and nominal bond risk premia and macroeconomic dynamics are explored quantitatively in a model with nominal rigidities and monetary policy. The estimated model captures macroeconomic and yield curve properties of the U.S. economy, implying significantly positive real term and inflation risk bond premia. In contrast to previous literature, both premia are positive and generated by wage rigidities as a compensation for permanent productivity shocks. Stronger policy-rule responses to inflation (output) increase (decrease) both premia, while policy surprises generate negligible risk premia. Empirical evidence of the economic mechanism is provided.
Keywords: Bond risk premia, Monetary policy, Nominal rigidities, Yield curve
Government-Backed Mortgage Insurance, Financial Crisis, and the Recovery from the Great Recession (PDF)
Abstract: The Great Recession provides an opportunity to test the proposition that government mortgage insurance programs mitigated the effects of the financial crisis and enhanced the economic recovery from 2009 to 2014. We find that government-sponsored mortgage insurance programs have been responsible for better economic outcomes in counties that participated heavily in these programs. In particular, counties with high levels of participation from government-sponsored enterprises and the Federal Housing Authority had relatively lower unemployment rates, higher home sales, higher home prices, lower mortgage delinquency rates, and less foreclosure activity, both in 2009 (soon after the peak of the financial crisis) and in 2014 (six years after the crisis) than did counties with lower levels of participation. The persistence of better outcomes in counties with heavy participation in federal government programs is consistent with a view that lower government liquidity premiums , lower government credit-risk premiums, and looser government mortgage-underwriting standards yield higher private-sector economic activity after a financial crisis.
Keywords: Financial crisis, Great Recssion, government policy, mortgages
Only Winners in Tough Times Repeat: Hedge Fund Performance Persistence over Different Market Conditions (PDF)
Zheng Sun, Ashley W. Wang, and Lu Zheng
Abstract: We provide novel evidence that hedge fund performance is persistent following weak hedge fund markets, but is not persistent following strong markets. Specifically, we construct two performance measures, DownsideReturns and UpsideReturns, conditioned on the level of overall hedge fund sector returns. After adjusting for risks, funds in the highest DownsideReturns quintile outperform funds in the lowest quintile by about 7% in the subsequent year, whereas funds with better UpsideReturns do not outperform subsequently. The DownsideReturns can predict future fund performance over a horizon as long as 3 years, for both winners and losers, and for funds with few share restrictions.
Keywords: Conditional performance, Hedge funds, Performance Persistence
Abstract: This paper examines the effect of increased market concentration of the banking industry caused by the Riegle-Neal Interstate Banking and Branching Efficiency Act (IBBEA) on the availability of finance for small firms engaged in research and development (R&D). I measure the financing decisions of these small firms using a balanced panel of Small Business Innovation Research (SBIR) applications. Using difference-in-differences, I find IBBEA decreased the supply of finance for small R&D firms. This effect is larger for late adopters of IBBEA, which tended to be states with stronger small banking sectors pre-IBBEA.
Keywords: Banking Deregulation, IBBEA, Interstate Bank Branching Deregulation, Market Concentration, Research and Development, Riegle-Neal, Small Business Innovation Research
State Capacity and Public Goods: Institutional Change, Human Capital, and Growth in Early Modern Germany (PDF)
Jeremiah E. Dittmar and Ralf R. Meisenzahl
Abstract: What are the origins and consequences of the state as a provider of public goods? We study legal reforms that established mass public education and increased state capacity in German cities during the 1500s. These fundamental changes in public goods provision occurred where ideological competition during the Protestant Reformation interacted with popular politics at the local level. We document that cities that formalized public goods provision in the 1500s began differentially producing and attracting upper tail human capital and grew to be significantly larger in the long-run. We study plague outbreaks in a narrow time period as exogenous shocks to local politics and find support for a causal interpretation of the relationship between public goods institutions, human capital, and growth. More broadly, we provide evidence on the origins of state capacity directly targeting welfare improvement.
Keywords: Education, Growth, Human Capital, Institutions, Persistence, State Capacity
From Which Consumption-Based Asset Pricing Models Can Investors Profit? Evidence from Model-Based Priors (PDF)
Abstract: This paper compares consumption-based asset pricing models on the basis of whether they can improve the forecast accuracy of investors who try to predict the equity premium out-of-sample with valuation ratios. Model-based priors are derived from three prominent consumption-based asset pricing models: Habit Formation, Long Run Risk, and Prospect Theory. A simple Bayesian framework is proposed through which the investors impose these model-based priors on the parameters of their predictive models. An investor whose prior beliefs are rooted in the Long Run Risk model achieves more accurate forecasts overall. The greatest difference in performance occurs during the bull market of the late 1990s. During this period, the weak predictability of the equity premium implied by the Long Run Risk model helps the investor to not prematurely anticipate falling stock prices.
Keywords: Bayesian econometrics, consumption-based asset pricing, return predictability
Gazi I. Kara and S. Mehmet Ozsoy
Abstract: This paper examines the optimal design of and interaction between capital and liquidity regulations in a model characterized by fire sale externalities. In the model, banks can insure against potential liquidity shocks by hoarding sufficient precautionary liquid assets. However, it is never optimal to fully insure, so realized liquidity shocks trigger an asset fire sale. Banks, not internalizing the fire sale externality, overinvest in the risky asset and underinvest in the liquid asset in the unregulated competitive equilibrium. Capital requirements can lead to less severe fire sales by addressing the inefficiency and reducing risky assets--however, we show that banks respond to stricter capital requirements by decreasing their liquidity ratios. Anticipating this response, the regulator preemptively sets capital ratios at high levels. Ultimately, this interplay between banks and the regulator leads to inefficiently low levels of risky assets and liquidity. Macroprudential liquidity requirements that complement capital regulations, as in Basel III, restore constrained efficiency, improve financial stability and allow for a higher level of investment in risky assets.
Keywords: Bank capital regulation, Basel III, fire sale externality, liquidity regulation
The impact of unconventional monetary policy on firm financing constraints: Evidence from the maturity extension program (PDF)
Nathan Foley-Fisher, Rodney Ramcharan, and Edison Yu
Abstract: This paper investigates the impact of unconventional monetary policy on firm financial constraints. It focuses on the Federal Reserve's maturity extension program (MEP), intended to lower longer term rates and flatten the yield curve by reducing the supply of long-term government debt. Consistent with those models that emphasize bond market segmentation and limits to arbitrage, around the MEP's announcement, stock prices rose most sharply for those firms that are more dependent on longer-term debt. These firms also issued more long-term debt during the MEP and expanded employment and investment. These responses are most pronounced for those firms that are larger and older, and hence less likely to be financially constrained. There is also evidence of "reach for yield" behavior among some institutional investors, as the demand for riskier corporate debt also rose during the MEP. Our results suggest that unconventional monetary policy might have helped to relax financial constraints for some types of firms in part by inducing gap-filling behavior and affecting the pricing of risk in the bond market.
Keywords: Bond markets, firm-financial constraints, unconventional monetary policy
Matteo Barigozzi, Marco Lippi, and Matteo Luciani
Abstract: We develop the econometric theory for Non-Stationary Dynamic Factor models for large panels of time series, with a particular focus on building estimators of impulse response functions to unexpected macroeconomic shocks. We derive conditions for consistent estimation of the model as both the cross-sectional size, n, and the time dimension, T, go to infinity, and whether or not cointegration is imposed. We also propose a new estimator for the non-stationary common factors, as well as an information criterion to determine the number of common trends. Finally, the numerical properties of our estimator are explored by means of a MonteCarlo exercise and of a real-data application, in which we study the effects of monetary policy and supply shocks on the US economy.
Keywords: Dynamic Factor models, common trends, impulse response functions, unit root processes
Abstract: We examine how market participants have used the Federal Reserve's overnight reverse repurchase (ON RRP) exercise and how short-term interest rates have evolved between December 2013 and November 2014. We show that money market fund (MMF) participation is sensitive to the spread between market repo rates and the ON RRP offering rate as well as Treasury bill issuance, government sponsored enterprise (GSE) participation is more heavily driven by calendar effects, dealers tend to only participate when rate spreads are negative, and banks generally do not participate. We also find that the effect of the ON RRP on overnight interest rates is more significant in the collateralized market than the uncollateralized market.
Keywords: Federal Reserve System operations, Monetary policy, federal funds, money market funds, overnight RRP, repurchase agreements
Abstract: While many studies find that the tail distribution of high frequency stock returns follow a power law, there are only a few explanations for this finding. This study presents evidence that time-varying volatility can account for the power law property of high frequency stock returns. The power law coefficients obtained by estimating a conditional normal model with nonparametric volatility show a striking correspondence to the power law coefficients estimated from returns data for stocks in the Dow Jones index. A cross-sectional regression of the data coefficients on the model-implied coefficients yields a slope close to one, supportive of the hypothesis that the two sets of power law coefficients are identical. Further, for most of the stocks in the sample taken individually, the model-implied coefficient falls within the 95 percent confidence interval for the coefficient estimated from returns data.
Keywords: High frequency returns, Power laws, Tail distributions, Time-varying volatility
Jeff Larrimore, Jenny Schuetz, and Samuel Dodini
Abstract: As the U.S. emerges from the Great Recession, there is concern about slowing rates of new household formation and declining interest in homeownership, especially among younger households. Potential reasons that have been posited include tight mortgage credit and housing supply, changing preferences over tenure in the wake of the foreclosure crisis, and weak labor markets for young workers. In this paper, we examine how individual housing choices, and the stated motivations for these choices, reflect local housing affordability and individual financial circumstances, focusing particularly on young households. The analysis makes use of new individual-level data from the Survey of Household Economics and Decisionmaking (SHED). We find that housing affordability is correlated with county-level tenure rates and individual-level probability of homeownership for households with heads under age 40. However, it appears that young households' perceived barriers to homeownership are more closely related to individual financial circumstances than local housing market conditions.
Keywords: Housing demand, consumer preferences, household formation, tenure choice
Jenny Schuetz, Genevieve Giuliano, and Eun Jin Shin
Abstract: Despite its reputation as a car-oriented city, the Los Angeles metropolitan area has made substantial investments in developing rail transit since 1990. In cities with older "legacy" rail systems, the built environment has developed over time around fixed transit infrastructure, creating land use patterns oriented towards long-standing rail stations. By contrast, rail stations in Los Angeles were added to an already dense built environment, with auto oriented zoning and established land use patterns. In this paper we ask whether redevelopment is occurring around Los Angeles' rail stations, and whether zoning and related public policies are facilitating or constraining transit-oriented development. We conduct case studies of six Metro rail stations in the Los Angeles region, documenting the existing built environment, key components of zoning and land use planning, and the extent and type of new development in the immediate vicinity of stations after they opened. Results illustrate that redevelopment around transit stations involves complex interactions between physical environment, economic conditions and public interventions. Incompatible zoning and related land use policies may constrain growth near stations, but TOD-friendly zoning alone is not sufficient to spur development.
Keywords: Public transportation, housing markets, land use planning, local government, urban spatial structure, zoning
Abstract: The importance of financial frictions for the business cycle is widely recognized, but it is less recognized that their effects depend heavily on the underlying asset pricing theory. This paper examines the implications of learning-based asset pricing. I construct a model in which firms' ability to access credit depends on their market value, and investors rely on past observation to predict future stock prices. Agents' expectations remain model-consistent conditional on their beliefs about stock prices, which disciplines the expectation formation process. The model matches several asset price properties such as return volatility and predictability and also leads to a powerful feedback loop between asset prices and real activity, substantially amplifying business cycle shocks. Agents' expectational errors on asset prices spill over to forecasts of economic activity, resulting in forecast error predictability that closely matches survey data. A reaction of monetary policy to asset prices is welfare-improving under learning but not under rational expectations.
Keywords: Asset Pricing, Credit Constraints, Learning, Monetary policy, Survey Data
Matteo Barigozzi, Marco Lippi, and Matteo Luciani
Abstract: The paper studies Non-Stationary Dynamic Factor Models such that: (1) the factors F are I(1) and singular, i.e. F has dimension r and is driven by a q-dimensional white noise, the common shocks, with q < r, and (2) the idiosyncratic components are I(1). We show that F is driven by r-c permanent shocks, where c is the cointegration rank of F, and q-(r-c) < c transitory shocks, thus the same result as in the non-singular case for the permanent shocks but not for the transitory shocks. Our main result is obtained by combining the classic Granger Representation Theorem with recent results by Anderson and Deistler on singular stochastic vectors: if (1-L)F is singular and has rational spectral density then, for generic values of the parameters, F has an autoregressive representation with a finite-degree matrix polynomial fulfilling the restrictions of a Vector Error Correction Mechanism with c error terms. This result is the basis for consistent estimation of Non-Stat ionary Dynamic Factor Models. The relationship between cointegration of the factors and cointegration of the observable variables is also discussed.
Keywords: Cointegration for singular vectors, Dynamic Factor Models for I(1) variables, Granger Representation Theorem for singular vectors
David M. Byrne, John G. Fernald, and Marshall B. Reinsdorf
Abstract: After 2004, measured growth in labor productivity and total-factor productivity (TFP) slowed. We find little evidence that the slowdown arises from growing mismeasurement of the gains from innovation in IT-related goods and services. First, mismeasurement of IT hardware is significant prior to the slowdown. Because the domestic production of these products has fallen, the quantitative effect on productivity was larger in the 1995-2004 period than since, despite mismeasurement worsening for some types of IT--so our adjustments make the slowdown in labor productivity worse. The effect on TFP is more muted. Second, many of the tremendous consumer benefits from smartphones, Google searches, and Facebook are, conceptually, non-market: Consumers are more productive in using their nonmarket time to produce services they value. These benefits do not mean that market-sector production functions are shifting out more rapidly than measured, even if consumer welfare is rising. Still, gains in non-market production appear too small to compensate for the loss in overall wellbeing from slower market-sector productivity growth. Third, other measurement issues we can quantify (such as increasing globalization and fracking) are also quantitatively small relative to the slowdown. Finally, we suggest high-priority areas for future research.
Keywords: Information technology, Measurement, Non-market production, Prices, Productivity
Sian L. Seldin
Abstract: The Board of Governors of the Federal Reserve System has published extensive statistical information on the U.S. economy and banking industry since 1914. This information has been published in various formats, usually referred to as "statistical releases." Titles and release numbers of the publications have changed frequently. Federal Reserve Board Statistical Releases: a Publications History describes these changes; it is a convenient tool that lightens the burden of tracing the titles and release numbers by providing history in a single location.
Keywords: Data collection and estimation, Economic history, Federal Reserve Board and Federal Reserve System
Raven S. Molloy, Christopher L. Smith, Riccardo Trezzi, and Abigail Wozniak
Abstract: We document a clear downward trend in labor market fluidity that is common across a variety of measures of worker and job turnover. This trend dates to at least the early 1980s if not somewhat earlier. Next we pull together evidence on a variety of hypotheses that might explain this downward trend. It is only partly related to population demographics and is not due to the secular shift in industrial composition. Moreover, the decline in labor market fluidity seems unlikely to have been caused by an improvement in worker-firm matching, the formalization of hiring practices, or an increase in land use regulation or other regulations. Plausible avenues for further exploration include changes in the worker-firm relationship, particularly with regard to compensation adjustment; changes in firm characteristics such as firm size and age; and a decline in social trust, which may have increased the cost of job search or made both parties in the hiring process more risk averse.
Keywords: demographic trends, hires and separations, job creation and destruction, job turnover, labor market churn, labor market transitions, labor reallocation
Abstract: Deadlines and fixed end dates are pervasive in matching markets including school choice, the market for new graduates, and even financial markets such as the market for federal funds. Deadlines drive fundamental non-stationarity and complexity in behavior, generating significant departures from the steady-state equilibria usually studied in the search and matching literature. I consider a two-sided matching market with search frictions where vertically differentiated agents attempt to form bilateral matches before a deadline. I give conditions for existence and uniqueness of equilibria, and show that all equilibria exhibit an "anticipation effect" where less attractive agents become increasingly choosy over time, preferring to wait for the opportunity to match with attractive agents who, in turn, become less selective as the deadline approaches. When payoffs accrue after the deadline, or agents do not discount, a sharp characterization is available: at any point in t ime, the market is segmented into a first class of matching agents and a second class of waiting agents. This points to a different interpretation of unraveling observed in some markets and provides a benchmark for other studies of non-stationary matching. A simple intervention -- a small participation cost -- can dramatically improve efficiency.
Keywords: Deadlines, matching, nonstationary dynamics, search
Abstract: In this paper, I examine the effects of a countercyclical fiscal policy that gave firms additional tax refunds--additional liquidity--at the end of the past two recessions. I take advantage of a discontinuity in the slope of the tax refund formula to estimate the policy's impact. I find that after passage of the policy in 2002, firms allocated $0.40 of every tax refund dollar to investment. After passage of the policy in 2009, in contrast, firms used the refunds to increase cash holdings ($0.96 of every refund dollar) before paying down debt in the following year. I provide evidence that differences in macroeconomic conditions across the two periods drove these differences in firm responses, illustrating how the effects of stimulus vary across recessionary states of the world. I also show that while the policy had no discernable effect on investment in the most recent recessionary period, it did reduce firms' bankruptcy risk and the probability of a future credit- rating downgrade.
Keywords: Financing policy, fiscal policy, fixed investment, taxation
Hie Joo Ahn and James D. Hamilton
Abstract: This paper develops new estimates of flows into and out of unemployment that allow for unobserved heterogeneity across workers as well as direct effects of unemployment duration on unemployment-exit probabilities. Unlike any previous paper in this literature, we develop a complete dynamic statistical model that allows us to measure the contribution of different shocks to the short-run, medium-run, and long-run variance of unemployment as well as to specific historical episodes. We find that changes in the inflows of newly unemployed are the key driver of economic recessions and identify an increase in permanent job loss as the most important factor.
Keywords: Great Recession, business cycles, duration dependence, extended Kalman filter, state space model, unemployment duration, unobserved heterogeneity
Thomas Laubach and John C. Williams
Abstract: Persistently low real interest rates have prompted the question whether low interest rates are here to stay. This essay assesses the empirical evidence regarding the natural rate of interest in the United States using the Laubach-Williams model. Since the start of the Great Recession, the estimated natural rate of interest fell sharply and shows no sign of recovering. These results are robust to alternative model specifications. If the natural rate remains low, future episodes of hitting the zero lower bound are likely to be frequent and long-lasting. In addition, uncertainty about the natural rate argues for policy approaches that are more robust to mismeasurement of natural rates.
Keywords: Econometrics, Money and interest rates
Abstract: This paper estimates the effect of student loan debt on subsequent homeownership in a uniquely constructed administrative data set for a nationally representative cohort aged 23 to 31 in 2004 and followed over time, from 1997 to 2010. Our unique data combine anonymized individual credit bureau data with college enrollment histories and school characteristics associated with each enrollment spell, as well as several other data sources. To identify the causal effect of student loans on homeownership, we instrument for the amount of the individual's student loan debt using changes to the in-state tuition rate at public 4-year colleges in the student's home state. We find that a 10 percent increase in student loan debt causes a 1 to 2 percentage point drop in the homeownership rate for student loan borrowers during the first five years after exiting school. Validity tests suggest that the results are not confounded by local economic conditions or non-random selection int o the estimation sample.
Keywords: Credit Constraints, Homeowernship, Student loans
Timothy S. Hills, Taisuke Nakata, and Sebastian Schmidt
Abstract: Even when the policy rate is currently not constrained by its effective lower bound (ELB), the possibility that the policy rate will become constrained in the future lowers today's inflation by creating tail risk in future inflation and thus reducing expected inflation. In an empirically rich model calibrated to match key features of the U.S. economy, we find that the tail risk induced by the ELB causes inflation to undershoot the target rate of 2 percent by as much as 45 basis points at the economy's risky steady state. Our model suggests that achieving the inflation target may be more difficult now than before the Great Recession, if the recent ELB experience has led households and firms to revise up their estimate of the ELB frequency.
Keywords: Deflationary Bias, Disinflation, Inflation Targeting, Risky Steady State, Tail Risk, Zero Lower Bound
Abstract: Can policies directed at the banking sector in one jurisdiction spill over and affect real economic activity elsewhere? To investigate this question, I exploit changes in tax rates on bank profits across U.S. states. Banks respond by reallocating small-business lending to otherwise unaffected states. Moreover, counties in non-tax-changing states that have more exposure to "treated" banks experience greater changes in lending, which in turn impacts local employment. The findings demonstrate that policies aimed at the banking sector in one jurisdiction can impose externalities on other regions. Critically, financial linkages between regions serve as the transmission channel for these policy externalities.
Keywords: Banks, Credit Supply, Internal Capital Markets, Policy Arbitrage, Small Business Lending, Taxation
Luca Guerrieri, Dale Henderson, and Jinill Kim
Abstract: Consumption and investment comove over the business cycle in response to shocks that permanently move the price of investment. The interpretation of these shocks has relied on standard one-sector models or on models with two or more sectors that can be aggregated. However, the same interpretation continues to go through in models that cannot be aggregated into a standard one-sector model. Furthermore, such a two-sector model with distinct factor input shares across production sectors and commingling of sectoral outputs in the assembly of final consumption and investment goods, in line with the U.S. Input-Output Tables, has implications for aggregate variables. It yields a closer match to the empirical evidence of positive comovement for consumption and investment.
Keywords: DSGE Models, Long-Run Restrictions, Multi-Sector Models, Vector Auto-Regressions
Alexander Ljungqvist and Michael Smolyansky
Abstract: Do corporate tax increases destroy jobs? And do corporate tax cuts boost employment? Answering these questions has proved empirically challenging. We propose an identification strategy that exploits variation in corporate income tax rates across U.S. states. Comparing contiguous counties straddling state borders over the period 1970 to 2010, we find that increases in corporate tax rates lead to significant reductions in employment and income. We find little evidence that corporate tax cuts boost economic activity, unless implemented during recessions when they lead to significant increases in employment and income. Our spatial-discontinuity approach permits a causal interpretation of these findings by both establishing a plausible counterfactual and overcoming biases resulting from the fact that tax changes are often prompted by changes in economic conditions.
Keywords: Corporate taxation, economic growth, economic stimulus, employment, fiscal policy, regional economies
Abstract: This paper explores the economic issues related to systemically important insurance companies, using an example from the Great Depression, the National Surety Company. National Surety was a large and diverse insurance company that experienced a major crisis in 1933 due to losses from its guarantees of mortgage-backed securities. A liquidity crisis ensued, as policyholders staged a massive run on the company, demanding the return of their unearned premiums. The New York State Insurance Commissioner stepped in with a reorganization plan that split the company in two, out of fear that a disorderly liquidation would have systemic consequences given the sheer number of the company's counterparties, scattered all across the United States. A key dynamic of the crisis was that policy holders at an insurance company have a dual role as holders of liabilities and as providers of income.
Keywords: Insurance, great depression, surety, systemic importance
Jenny Schuetz, Genevieve Giuliano, and Eun Jin Shin
Abstract: Over the past 20 years, local and regional governments in the Los Angeles metropolitan area have invested significant resources in building rail transit infrastructure that connects major employment centers. One goal of transit infrastructure is to catalyze the development of high density, mixed-use housing and commercial activity within walking distance of rail stations, referred to as Transit Oriented Development (TOD). This project examines the quantity, type, and mix of economic activity that has occurred around newly built rail stations in Los Angeles over the past 20 years. Specifically, have the number of jobs or housing market characteristics changed near stations? We use establishment-level data on employment and property-level data on housing transactions to analyze changes in several employment and housing outcomes. Results suggest that new rail stations were located in areas that, prior to station opening, had unusually high employment density and mostly multifamily rental housing. There is no evidence of changes in employment density, housing sales volume, or new housing development within five years after station opening. Regressions suggest that a subset of stations saw increased employment density within five to ten years after opening.
Keywords: Economic development, housing markets, public transportation, urban spatial structure
Abstract: This paper analyzes the run on Continental Illinois in 1984. We find that the run slowed but did not stop following an extraordinary government intervention, which included the guarantee of all liabilities of the bank and a commitment to provide ongoing liquidity support. Continental's outflows were driven by a broad set of US and foreign financial institutions. These were large, sophisticated creditors with holdings far in excess of the insurance limit. During the initial run, creditors with relatively liquid balance sheets nevertheless withdrew more than other creditors, likely reflecting low tolerance to hold illiquid assets. In addition, smaller and more-distant creditors were more likely to withdraw. In the second and more drawn out phase of the run, institutions with relative large exposures to Continental were more likely to withdraw, reflecting a general unwillingness to have an outsized exposure to a troubled institution even in the absence of credit risk. Finally, we show that the concentration of holdings of Continental's liabilities was a key dynamic in the run and was importantly linked to Continental's systemic importance.
Keywords: Bank runs, deposit guarantee, deposit insurance, financial crisis
Filippo Curti and Marco Migueis
Abstract: Operational risk models, such as the loss distribution approach, frequently use past internal losses to forecast operational loss exposure. However, the ability of past losses to predict exposure, particularly tail exposure, has not been thoroughly examined in the literature. In this paper, we test whether simple metrics derived from past loss experience are predictive of future tail operational loss exposure using quantile regression. We find evidence that past losses are predictive of future exposure, particularly metrics related to loss frequency.
Keywords: Operational risk, quantile regression, tail risk
Bruce C. Fallick, Michael Lettau, and William L. Wascher
Abstract: Rigidity in wages has long been thought to impede the functioning of labor markets. One recent strand of the research on wage flexibility in the United States and elsewhere has focused on the possibility of downward nominal wage rigidity and what implications such rigidity might have for the macroeconomy at low levels of inflation. The Great Recession of 2008-09, during which the unemployment rate topped 10 percent and price deflation was at times seen as a distinct possibility, along with the subsequent slow recovery and persistently low inflation, has added to the relevance of this line of inquiry. In this paper, we use establishment-level data from a nationally representative establishment-based compensation survey collected by the Bureau of Labor Statistics to investigate the extent to which downward nominal wage rigidity is present in U.S. labor markets. We use several distinct methods proposed in the literature to test for downward nominal wage rigidity, and to as sess whether such rigidity is more severe at low rates of inflation and in the presence of negative economic shocks than in more normal economic times. Like earlier studies, we find evidence of a significant amount of downward nominal wage rigidity in the United States. We find no evidence that the high degree of labor market distress during the Great Recession reduced the amount of downward nominal wage rigidity and some evidence that operative rigidity may have increased during that period.
Keywords: labor markets, wage rigidity