Financial firm resolution policy as a time-consistency problem

In this article, we describe a time-consistency problem that can arise in the government's policy toward insolvent financial firms. We present this problem using a simple model in which shareholders of a large financial firm can raise low-cost debt financing and take on an excessive amount of risk. If this risk backfires, there are spillover effects harmful to the economy as a whole. In such a crisis event, the government's best action is to bail the firm out. The prospect of this bailout is the very reason why the firm can raise debt at low cost while taking on excessive risk. Given the structure of this problem, we discuss government policy that can eliminate or mitigate excessive risk-taking. Efficient resolution policy can eliminate excessive risk-taking only if it can completely eliminate the negative spillover effect. Alternatively, excessive risk-taking can be eliminated either directly by accurate government supervision of system-wide risk-taking, or indirectly by imposing binding capital requirements.Financial markets

Optimal nonlinear income taxation with costly tax avoidance

Taxation

Opinion : When disclosure is not enough

Mortgages ; Consumers

Distortionary taxation for efficient redistribution

This article uses a simple model to review the economic theory of efficient redistributive taxation. The model economy is a Lucas-tree economy, in which income comes from a stock of productive capital. Agents, who own the capital stock, are heterogenous with respect to their preference for early versus late consumption. A competitive capital market, in equilibrium, supports a unique Pareto-efficient allocation of consumption among the agents, i.e., the First Welfare Theorem holds. The equilibrium allocation represents one efficient division of the total gains from trade that are available in the economy. All other efficient divisions of the gains from trade, represented by a continuum of other Pareto-efficient allocations, are inconsistent with competitive capital market equilibrium. If agents' preference types are public information, nondistortionary wealth transfers are sufficient to implement any Pareto optimum as a market equilibrium, i.e., the classic Second Welfare Theorem holds. If agents' preferences are private information, however, the classic Second Welfare Theorem fails. A class of distortionary tax systems is characterized under which a modified Second Welfare Theorem holds: Every constrained-Pareto-optimal allocation can be supported as an equilibrium subject to distortionary taxes.Taxation

Borrowing Constraint as an Optimal Contract

We study a continuous-time version of the optimal risk-sharing problem with one-sided commitment. In the optimal contract, the agent's consumption is non-decreasing and depends only on the maximal level of the agent's income realized to date. In the complete-markets implementation of the optimal contract, the Alvarez-Jermann solvency constraints take the form of a simple borrowing constraint familiar from the Bewley-Aiyagari incomplete-markets models. Unlike in the incomplete-markets models, however, the asset buffer stock held by the agent is negatively correlated with income.Borrowing constraint, limited commitment

Nonseparable Preferences and Optimal Social Security Systems

In this paper, we consider economies in which agents are privately informed about their skills, which are evolving stochastically over time. We require agents' preferences to be weakly separable between the lifetime paths of consumption and labor. However, we allow for intertemporal nonseparabilities in preferences like habit formation. We show that such nonseparabilities imply that optimal asset income taxes are necessarily retrospective in nature. We show that under weak conditions, it is possible to implement a socially optimal allocation using a social security system in which taxes on wealth are linear, and taxes/transfers are history-dependent only at retirement. The average asset income tax in this system is zero.

Nonseparable Preferences and Optimal Social Security systems

In this paper, we consider economies in which agents are privately informed about their skills, which are evolving stochastically over time. We require agents’ preferences to be weakly separable between the lifetime paths of consumption and labor. However, we allow for intertemporal nonseparabilities in preferences like habit formation. We show that such nonseparabilities imply that optimal asset income taxes are necessarily retrospective in nature. We show that under weak conditions, it is possible to implement a socially optimal allocation using a social security system in which taxes on wealth are linear, and taxes/transfers are history-dependent only at retirement. The average asset income tax in this system is zero.Nonseparable Preferences, Social Security

Structural investigations of the regio- and enantioselectivity of lipases

Although lipases are widely applied for the stereospecific resolution of racemic mixtures of esters, the atomic details of the factors that are responsible for their stereospecificity are largely obscure. We determined the X-ray structures of Pseudomonas cepacia lipase in complex with two enantiopure triglyceride analogues, that closely mimic natural substrates. This allowed an unambiguous view of how the two wings of the boomerang-shaped active site accommodate the acyl and alcohol parts of the triglyceride. The binding groove for the hydrophobic sn-3 fatty acid chain is large and hydrophobic. The cleft for the alcohol moiety is divided in two parts, one tightly binding the sn-2 acyl chain with hydrophilic and hydrophobic interactions, the other more weakly binding the sn-1 fatty acid. The enantioselectivity of Pseudomonas cepacia lipase seems therefore to be predominantly determined by the size and interactions of the sn-2 chain and by the size of the sn-3 chain.

Market-based incentives

We study optimal incentives in a principal-agent problem in which the agent's outside option is determined endogenously in a competitive labor market. In equilibrium, strong performance increases the agent's market value. When this value becomes sufficiently high, the threat of the agent's quitting forces the principal to give the agent a raise. The prospect of obtaining this raise gives the agent an incentive to exert effort, which reduces the need for standard incentives, like bonuses. In fact, whenever the agent's option to quit is close to being ``in the money,'' the market-induced incentive completely eliminates the need for standard incentives

Market-based incentives

We study optimal incentives in a principal-agent problem in which the agent's outside option is determined endogenously in a competitive labor market. In equilibrium, strong performance increases the agent's market value. When this value becomes sufficiently high, the threat of the agent's quitting forces the principal to give the agent a raise. The prospect of obtaining this raise gives the agent an incentive to exert effort, which reduces the need for standard incentives, like bonuses. In fact, whenever the agent's option to quit is close to being ``in the money,'' the market-induced incentive completely eliminates the need for standard incentives