Borrower heterogeneity within a risky mortgage-lending market

We propose a model of a risky mortgage-lending market in which we take explicit account of heterogeneity in household borrowing conditions, by introducing two borrower types: one with a low loan-to-value (LTV) ratio, one with a high LTV ratio, calibrated to U.S. data. We use such framework to study a deleveraging shock, modeled as an increase in housing investment risk, that falls more strongly on, and produces a larger contraction in credit for high-LTV type borrowers, as in the data. We find that this deleveraging experience produces significant aggregate effects on output and consumption, and that the contractionary effects are orders of magnitudes higher in a model version that takes account of borrower heterogeneity, compared to a more standard model version with a representative borrower

Monetary transmission under competing corporate finance regimes

The behavioural agent-based framework of De Grauwe and Gerba (2015) is extended to allow for a counterfactual exercise on the role of banks for monetary transmissions. A bank-based corporate financing friction is introduced and the relative contribution of that friction to the effectiveness of monetary policy is evaluated. We find convincing evidence that the monetary transmission channel is stronger in the bank-based system compared to the market-based. Impulse responses to a monetary expansion are around the double of those in the market-based framework. The (asymmetric) effectiveness of monetary policy in counteracting busts is, on the other hand, relatively higher in the market-based model. The statistical fit of the bank-based behavioural model is also improved compared to the benchmark model. Lastly, we find that a market-based (bankbased) financing friction in a general equilibrium produces highly asymmetric (symmetric) distributions and more (less) pronounced business cycles

Buffer stock savings in a New-Keynesian business cycle model

We introduce the tractable buffer stock savings setup of Carroll and Toche (2009 NBER Working Paper) into an otherwise conventional New-Keynesian dynamic stochastic general equilibrium model with financial frictions. The introduction of a precautionary saving motive arising from an uninsurable risk of permanent income loss, affects the model's properties in a number of interesting ways: it produces a more hump-shaped reaction of consumption in response to both supply (technology) and demand (monetary) shocks, and more pronounced reactions in response to demand shocks. Adoption of the buffer stock savings setup thus offers a more microfounded way, compared to, e.g., habit preferences in consumption, to introduce Keynesian features into the model, serving as a device to curbing excessive consumption smoothing, and to attributing a higher role to demand driven fluctuations. We also discuss steady state effects, determinacy properties as well as other practical issues

Financial market dynamics and regulation

[Introduction] The current banking regulation laid down, for example, in the Capital Requirements Regulation and Directive (CRR/CRD IV) for the European Union, consist of a large number of detailed rules for diverse areas of bank risk such as market risk, liquidity risk, credit risk, and operational risk, just to mention the most important. Even for individual regulatory measures such as the minimum capital requirements, it is difficult to assess the effects on a single bank, but very hard to get an estimate for the complete banking sector. However, from an economic policy perspective it is necessary to know how a regulatory measure will affect economic development and growth. It would be of even higher importance to have such knowledge for the regulatory rulebook as a whole, but this seems to be far beyond the scope of theoretical or applied economic models. The aim of our project was to develop a multi-purpose agent-based model targeted to measure the effects of banking regulation, both for the banking sector and for the whole economy. A first important application is to find out if and how strongly banking regulation impacts monetary policy. In the years after the beginning of the financial market crises (i.e. in the years after 2008) the European Central Bank (ECB) did a good job in preventing a collapse of the banking sector in the Eurozone. Nevertheless, even after many years of very low costs of loans for private households and companies (both in nominal and real terms), growth rates of loans to the private sector and M3 are still below pre-crisis levels. Also inflation is still far below the target level of the ECB. This shows in a glance how difficult it is for the ECB to normalise the transmission mechanism of monetary policy. [...

Fiscal policy and the term structure of interest rates in a DSGE model

We examine the role of government spending in the dynamics of the term structure of interest rates. Is the quantity of risk related government spending important for the price of risk? How does it depend on monetary policy conduct? Can fiscal policy immunize its impact on the term structure of interest rates? To answer this questions, we explore asset pricing implications of fiscal policy in what become paradigm in dynamic general equilibrium macro-finance literature. We break down the transmission of the government spending to macroeconomic attributes driving the dynamic response of the yield curve, both analytically and numerically. The novelty of our approach lies in the way we quantify the decomposition of pricing kernel. We find that rise in fiscal uncertainty amplifies the hedging property of bonds against real and nominal risks. Depending on the size of uncertainty monetary policy drives up the price of nominal risk. Spending reversals break the link between quantity and price of fiscal risk

Measuring the frequency dynamics of financial and macroeconomic connectedness

We propose a general framework for measuring frequency dynamics of connectedness in economic variables based on spectral representation of variance decompositions. We argue that the frequency dynamics is insightful when studying the connectedness of variables as shocks with heterogeneous frequency responses will create frequency dependent connections of different strength that remain hidden when time domain measures are used. Two applications support the usefulness of the discussion, guide a user to apply the methods in different situations, and contribute to the literature with important findings about sources of connectedness. Giving up the assumption of global stationarity of stock market data and approximating the dynamics locally, we document rich time-frequency dynamics of connectedness in US market risk in the first application. Controlling for common shocks due to common stochastic trends which dominate the connections, we identify connections of global economy at business cycle frequencies of 18 up to 96 months in the second application. In addition, we study the effects of cross-sectional dependence on the connectedness of variables

International housing markets, unconventional monetary policy and the zero lower bound

In this paper we propose a time-varying parameter VAR model for the housing market in the United States, the United Kingdom, Japan and the Euro Area. For these four economies, we answer the following research questions: (i) How can we evaluate the stance of monetary policy when the policy rate hits the zero lower bound? (ii) Can developments in the housing market still be explained by policy measures adopted by central banks? (iii) Did central banks succeed in mitigating the detrimental impact of the financial crisis on selected housing variables? We analyze the relationship between unconventional monetary policy and the housing markets by using the shadow interest rate estimated by Krippner (2013b). Our findings suggest that the monetary policy transmission mechanism to the housing market has not changed with the implementation of quantitative easing or forward guidance, and central banks can affect the composition of an investor's portfolio through investment in housing. A counterfactual exercise provides some evidence that unconventional monetary policy has been particularly successful in dampening the consequences of the financial crisis on housing markets in the United States, while the effects are more muted in the other countries considered in this study

State-of-the-Art of the Economics of Cyber-Security and Privacy

This document is an overview of the state-of-the-art in the economics of Privacy and Cyber-security (PACS). It is the Deliverable D4.1 under the FP7-financed project “Innovation Framework for Privacy and Cyber-security Market Opportunities.” This is the most comprehensive overview on the economics of PACS to date. This document is intended for a diverse readership. Policymakers may use it in order to obtain an overview of the most recent research and insights that can be derived on the effectiveness of specific policy measures (such as data breach notifications). Researchers can use it as introductory reading and to obtain an overview of the field. Innovators and entrepreneurs may use this report to obtain a better understanding of the market they are operating in. It is stated that Privacy and Cyber-security markets differ from bricks-and-mortar markets because of the immateriality of the products and services provided and because of amplified network externalities that exist in these markets. These can lead to inefficiencies in terms of social welfare, misleading price signals or even market breakdown. The first chapter of this report introduces the reader to the basic concepts of economics, economic incentives and incentivization as well as to decision-making in the cyber-security domain. It covers proactive and reactive investment strategies, components of the cost/benefits of PACS investments and the security returns on investment model. The diverse field of cyber-economics is then mapped by sorting the research works into 5 areas: (1) game-theoretical approaches to cyber-security; (2) Experimental and psychological research; (3) Victim studies; (4) Methodological Advances; and (5) Other research. One of the most important parts of the document is the discussion of market failures in cyber-security markets and problems such as information asymmetries, networks externalities, public goods, interdependent security and natural monopoly cost structures. In the chapter on the economics of privacy, basic concepts are discussed such as the different types of transactions that exist. The literatures in this field are sorted into the following categories: (1) Empirical works (laboratory experiments and surveys); (2) Hypothetical scenarios; (3) Field experiments (including survey-based experiments); and other research (including methodological advances). Market failure problems are also discussed for markets for personal data products/services and privacy products/services. Other topics covered in that chapter span from the challenges of privacy preference measurement to the development of privacy metrics. Moreover, attention is also devoted to the monetization of privacy and the economic value of personal data with different methods to obtain estimates of valuations. The conclusion from these sections is that it is a great challenge if not impossible to obtain an unbiased and exact estimate of the valuation of personal data. Much more effort needs to be invested in developing robust market mechanisms, where data subjects can actively participate. The report further covers policy-instruments and incentive schemes in the area of PACS, ranging from mandatory to voluntary instruments. Finally, the report concludes with an overview of research challenges for further work and for the future H2020 agenda

Credit networks, leverage and macro dynamics

[Introduction] The global crisis of 2007-2008 showed the limits of the mainstream economic models in dealing with complex contingent events as financial crises. Thus, following different methodologies, we developed models that describe the economy as a complex system that evolves according to the interactions of heterogeneous agents. Our models underline the importance the role played by credit network configurations and leverage cycles in determining macroeconomic dynamics. In order to develop macro-prudential policies aimed at increasing the resilience of the economic system, these models try to shed some light into the conditions that may foster the occurrence of crises. In particular, the models underline the importance of monitoring the evolution of credit networks in order to avoid the excessive concentration of the credit market in the hands of few central actors as large banks or firms which become 'too interconnected to fail'. Moreover, the models underline the importance of non-standard monetary policies during and after crises to avoid triggering a new recession ("double dip” recession). [...

Estimation of financial agent-based models with simulated maximum likelihood

This paper proposes a general computational framework for empirical estimation of financial agent based models, for which criterion functions do not have known analytical form. For this purpose, we adapt a nonparametric simulated maximum likelihood estimation based on kernel methods. Employing one of the most widely analysed heterogeneous agent models in the literature developed by Brock and Hommes (1998), we extensively test properties of the proposed estimator and its ability to recover parameters consistently and efficiently using simulations. Key empirical findings point us to the statistical insignificance of the switching coefficient but markedly significant belief parameters defining heterogeneous trading regimes with superiority of trend-following over contrarian strategies. In addition, we document slight proportional dominance of fundamentalists over trend following chartists in main world markets