Managerial incentives and financial contagion

This paper proposes a framework to examine the comovements of asset prices with seemingly unrelated fundamentals, as an outcome of the optimal portfolio strategies of large institutional fund managers. In emerging markets, the dominant presence of dedicated fund managers whose compensation is linked to the outperformance of their portfolio relative to a benchmark index, and of global fund managers whose compensation is linked to the absolute returns of their portfolios, leads to portfolio decisions that result in systematic interactions between asset prices even in the absence of asymmetric information. The model endogenously determines the optimal amount of cash holdings or leverage, the incidence of relative value versus macro hedge fund strategies, and how prices can systematically deviate from the long-term fundamental value for long periods of time, with limits to the arbitrage of this differential. Managerial compensation contracts, while optimal at a firm level, may lead to inefficiencies at the macroeconomic level. We identify conditions when a negative shock to one emerging market affects another market negatively.Financial crises ; Mutual funds

Managerial Incentives and Financial Contagion

This paper proposes a framework for comovements of asset prices with seemingly unrelated fundamentals, as an outcome of optimal portfolio strategies by fund managers. In emerging markets, dedicated managers outperforming a benchmark index and global managers maximizing absolute returns lead to systematic interactions between asset prices, without asymmetric information. The model determines optimal portfolio weights, the incidence of relative value strategies, and prices systematically deviating from fundamentals with limits to arbitraging this differential. Managerial compensation contracts, optimal at the firm level, may lead to inefficiencies at the macroeconomic level. We identify conditions when shocks in one emerging market affect others.Financial Crises, Index Investors, Global Linkages

New Zealand’s Social Assistance System: Financial Incentives to Work

This paper is a stock take of the financial incentives to work present in New Zealand’s social assistance system. The purpose of this paper is to provide a basis for research on problems facing the social assistance system and dilemmas that would be likely to arise when considering potential initiatives to address such problems. The current financial incentives to work contained in the social assistance system reflect efforts to tailor different financial incentives to different groups in the population. No single structure of financial incentives is appropriate for all people and at all times. It is therefore necessary from time to time to consider whether existing financial incentives continue to meet government objectives, such as encouraging work among different groups in the population. Improving the structure of financial incentives, however, defies simple solutions and requires trade-offs between competing and conflicting objectives to be made. In order to set the scene for later discussion, this paper begins with a brief description of the evolution of New Zealand’s social assistance system. This paper then moves on to discuss the financial returns from social assistance programmes and the distribution of the financial disincentives to work present in the current social assistance system. A number of further considerations are then discussed, particularly accommodation and childcare costs and the length of time that people tend to spend on social welfare benefits. This paper then considers the need for trade-offs between policy outcomes when developing policy initiatives to improve financial incentives to work before presenting a summary of its main findings. Appendixes to this paper describe the programmes that make up New Zealand’s three-tier social assistance system, key features of the personal income tax scale, a method for calculating Effective Marginal Tax Rates (EMTRs), and TaxMod and the Household Economic Survey (HES).Social Security, Social Assistance

Do Financial Incentives Affect Fertility?

This paper investigates how fertility responds to changes in the price of a marginal child and in household income. We construct a large, individual-level panel data set of married Israeli women during the period 1999–2005 that contains fertility histories and detailed controls. We exploit variation in Israel’s child subsidy program to identify changes in the price of a marginal child (using changes in the subsidy for a marginal child) and to instrument for household income (using changes in the subsidy for infra-marginal children). We find a significant and positive price effect on fertility: the mean level of marginal child subsidy produces a 7.8 percent increase in fertility. There is a positive effect within all religious and ethnic subgroups, including the ultra-Orthodox Jewish population, whose social and religious norms discourage family planning. There is also a significant price effect on fertility among women who are close to the end of their lifetime fertility, suggesting that at least part of the price effect is due to a reduction in total fertility. As expected, the child subsidy has no effect in the upper range of the income distribution. Finally, consistent with the predictions of Becker (1960) and Becker and Tomes (1976), we find that the income effect is small in magnitude and is negative at low income levels and positive at high levels.

Healthcare providers' views on the acceptability of financial incentives for breastfeeding:a qualitative study

BACKGROUND: Despite a gradual increase in breastfeeding rates, overall in the UK there are wide variations, with a trend towards breastfeeding rates at 6–8 weeks remaining below 40% in less affluent areas. While financial incentives have been used with varying success to encourage positive health related behaviour change, there is little research on their use in encouraging breastfeeding. In this paper, we report on healthcare providers’ views around whether using financial incentives in areas with low breastfeeding rates would be acceptable in principle. This research was part of a larger project looking at the development and feasibility testing of a financial incentive scheme for breastfeeding in preparation for a cluster randomised controlled trial. METHODS: Fifty–three healthcare providers were interviewed about their views on financial incentives for breastfeeding. Participants were purposively sampled to include a wide range of experience and roles associated with supporting mothers with infant feeding. Semi-structured individual and group interviews were conducted. Data were analysed thematically drawing on the principles of Framework Analysis. RESULTS: The key theme emerging from healthcare providers’ views on the acceptability of financial incentives for breastfeeding was their possible impact on ‘facilitating or impeding relationships’. Within this theme several additional aspects were discussed: the mother’s relationship with her healthcare provider and services, with her baby and her family, and with the wider community. In addition, a key priority for healthcare providers was that an incentive scheme should not impact negatively on their professional integrity and responsibility towards women. CONCLUSION: Healthcare providers believe that financial incentives could have both positive and negative impacts on a mother’s relationship with her family, baby and healthcare provider. When designing a financial incentive scheme we must take care to minimise the potential negative impacts that have been highlighted, while at the same time recognising the potential positive impacts for women in areas where breastfeeding rates are low

The effect of pension rules on retirement monetary incentives with an application to pension reforms in Spain

In this work we theoretically disentangle the effects of pension provisions on a variety of financial incentives to retirement, trying to reconcile them with some key Spanish retirement patterns. We find that the "average" individual, who is never affected by any cap of contributions or benefits, has weak incentives to retire early and strong incentives to retire at the normal retirement age. Alternatively, individuals at the bottom of the wage distribution have strong incentives to retire as early as possible, because ot the interaction between age-related penalties and the minimun pension. Both findings perfectly accommodate the retirement hazard of medium and low earners respectively. In contrast, high earners (those that have their contributions capped) despite having strong incentives to retire at the Early Retirement Age, do not do so. This is because, for those workers, financial incentives are not a good proxy for the marginal utility from working. Finally, we analyze the reasons behind the failure of the 1997 reform in improving the sustainability of the Spanish public pension system

"The Natural Instability of Financial Markets"

This paper contrasts the economic incentives implicit in the Keynes-Minsky approach to inherent financial market instability with the incentives behind the traditional equilibrium approach leading to market stability to provide a framework for analyzing the stability induced by the recent changes in bank regulation to modernize financial services and the evolution of financial engineering innovations in the U.S. financial system. It suggests that the changes that have occurred in the profit incentives for bank holding companies have modified the provision of liquidity to the financial system by banks, and the way credit assessment has moved from banks to other actors in the system. It takes the current experience in financial instability created by the expansion, through securitization, of the mortgage market as an example of these changes.

Circuit theory of finance and the role of incentives in financial sector reform

The author analyzes the financial system's role in economic growth and stability, addressing several core policy issues associated with financial sector reform in emerging economies. He studies finance's role in the context of a circuit model, with interacting rational, forward-looking, heterogeneous agents. He shows finance to essentially complement the price system in coordinating decentralized intertemporal resource allocation choices made by agents operating with limited information and incomplete trust. He discusses the links between finance and incentives for efficiency and stability in the context of the circuit model. He also identifies incentives and incentive-compatible institutions for reform strategies for financial sectors in emerging economies. Among his conclusions: 1) Circuit theory features important methodological advantages to analyze the role of finance, and to assess structural weaknesses of financial systems under different institutional settings and in different stages of economic development. 2) Incentives for prudence and honesty can protect the stability of the circuit by directing private sector forces unleashed by liberalization. In particular: a) Financial institutions should be encouraged to invest in reputational capital. b) Governments should complement the creation of franchise value by strengthening supervision and by adopting a regulatory regime based on rules designed to align the private incentives of market players with the social goal of financial stability. c) Safety nets to reduce systemic risk should minimize the moral hazard from stakeholders by limiting risk protection and by making the cost of protection sensitive to the risk taken. d) Governments should encourage self-policing in the financial sector. e) Where information and trust are scarce, there is a potential market for them, and governments can greatly improve incentives for optimal provision of information. f) Governments should strengthen the complementarity between the formal and the informal financial sectors. Emphasizing incentives is not to deny the importance of good rules, capable regulators andsupervisors, and strong enforcement measures. It is to suggest that the returns on investments to set up rules, institutions, and enforcement mechanisms can be greater if market players have an incentive to align their own objectives with the social goal of financial stability.Banks&Banking Reform,Economic Theory&Research,Payment Systems&Infrastructure,Environmental Economics&Policies,Financial Intermediation,Economic Theory&Research,Environmental Economics&Policies,Banks&Banking Reform,Financial Intermediation,International Terrorism&Counterterrorism

Tax and Benefit Reforms in a Model of Labour Market Transitions. ENEPRI Research Reports No. 25, 9 October 2006

This paper presents a method for taking advantage of labour market transitions to identify the effects of financial incentives on employment decisions. The framework used is very flexible and by imposing few theoretical assumptions it allows us to extend the modelled sample relative to structural models. The authors take advantage of this flexibility to include disabled persons in the model and to jointly analyse the behaviour of disabled and non-disabled persons. A great deal of attention is paid to the appropriate modelling of financial incentives in the labour market. In the case of disabled persons, taking account of financial incentives turns out to be an extremely complex process but one that in the end turns out to be well worth the effort. The model is used to compare reactions in the labour market to marginal changes in financial incentives and also to model one of the most important reforms of the UK Labour government – the introduction of the Working Families’ Tax Credit. The methodology relies on matching the transition and income data derived from cross-sectional and panel surveys, and could be used in other countries for which detailed, reliable income data are not collected in a panel format