Center for Financial Research
Externally Published ResearchLast Updated: February 13, 2019
CFR researchers publish peer reviewed articles and book reviews in academic journals, books, and other scholarly research outlets.
Recently Published Research
The Temporary Liquidity Guarantee Program: A Systemwide Systemic Risk Exception by Lee Davison. Journal of Financial Crises, Volume 1, Issue 2, 1-39.
In the fall of 2008, short-term credit markets were all but frozen, creating liquidity issues for banks and bank holding companies that could not rollover their debt at reasonable rates. Fearing that the situation would worsen if something was not done, the Federal Deposit Insurance Corporation (FDIC) and the Federal Reserve Board invoked, and the Secretary of the Treasury approved, the use of the “systemic risk exception” (SRE) under the Federal Deposit Insurance Corporation Improvement Act of 1991, to provide unprecedented broad-based relief to struggling banks. The SRE permitted the FDIC to depart from its “least-cost” requirement when addressing failing banks. Under the auspices of the SRE, the FDIC implemented two programs: (1) the Debt Guarantee Program (DGP), which extended the FDIC’s guarantee to newly issued debt instruments of FDIC-insured institutions, their holding companies, and their eligible affiliates; and (2) the Transaction Account Guarantee Program (TAGP), which provided unlimited deposit insurance coverage of non-interest-bearing transaction accounts. The DGP and TAGP were integral parts of a broad government response to systemic risk in the banking system and are considered successful elements thereof. Under the DGP, at peak usage, the FDIC guaranteed approximately $350 billion in newly issued bank debt. Under the TAGP, at peak usage, the FDIC guaranteed approximately $800 billion in non-interest-bearing transaction accounts at participating banks, offering for the first-time insurance over the statutory amount. The fees collected for the programs exceeded any losses covered by the government.
Business cycle implications of capacity constraints under demand shocks by Chacko George and Florian Kuhn. Review of Economic Dynamics, April 2019, Volume 32, 94-121
When capacity constraints limit the production of heterogeneous firms, demand shocks can endogenously generate a number of important business cycle regularities: recessions are deeper than booms, economic volatility is countercyclical, the aggregate Solow residual is procyclical and the fiscal multiplier is countercyclical. The model's main mechanism is that the share of firms at their production limit is strongly procyclical. A baseline calibration of a basic New Keynesian DSGE model with capacity constraints delivers more than 25% of the empirically observed asymmetry in output, 18% of the additional cross-sectional dispersion in recessions and around 25% of the additional aggregate volatility, and more than 50% of the fluctuations in the Solow residual. The model implies fluctuations in the fiscal multiplier of around 0.12 between expansions and recessions.
Outcome-robust mechanisms for Nash implementation by George F. N. Shoukry. Social Choice and Welfare, March 2019, Volume 52, Issue 3, 497-526.
Mechanisms for Nash implementation in the literature are fragile in the sense that they fail if just one or two players do not follow their equilibrium strategy. A mechanism is outcome-robust if its equilibrium outcome is not affected by any deviating minority of players. Is Nash implementation possible with outcome-robust mechanisms? I first show that in the standard environment, it is impossible to Nash-implement any nonconstant social choice rule with outcome-robust mechanisms even if a small number of players are partially honest. If simple transfers are used and if at least one player is partially honest, however, any social choice rule is Nash implementable using an outcome-robust mechanism. The mechanism presented in this paper makes no assumptions about how transfers enter players’ preferences except that transfers are valuable. Moreover, it has: no transfers in equilibrium, arbitrarily small off-equilibrium transfers, and no integer or modulo games.
Personal Bankruptcy, Asset Risk, and Entrepreneurship: Evidence from Tenancy-by-the-Entirety Laws by Jeffrey Traczynski. Journal of Law and Economics, February 2019, Volume 62, Issue 1, 151-179.
Personal bankruptcy law affects entrepreneurs’ decision-making and small-business credit markets. I show that personal asset protections affect small-business operations and funding sources using tenancy-by-the-entirety (TBE) laws, a novel source of variation in demand for loans and in bankruptcy exemptions. Tenancy-by-the-entirety laws are associated with firms having fewer business assets and less labor input from firms’ owners, which reflects possible moral hazard or credit constraints restricting firms’ asset accumulation. This effect arises through changes in firms’ funding sources necessary to obtain TBE protections. Unlike bankruptcy exemptions, I find no evidence that TBE laws are associated with higher rates of entrepreneurship.
The Second Bank of the United States: ‘Central’ Banker in an Era of Nation-Building by Claire Brennecke, for the Economic History Association. May 2018.
Deposit Rate Advantages at the Largest Banks by Stefan Jacewitz and Jon Pogach. Journal of Financial Services Research, February 2018, Volume 53, Issue 1, 1-35.
We estimate differences in funding costs between the largest banks and the rest of the industry. Using a novel dataset on deposit rates offered at the branch level, we document significant pricing advantages at the largest banks on comparable deposit products and deposit risk premiums. Between 2007 and 2008, the risk premium paid by the largest banks was 39 bps lower than the risk premium at other banks. This difference vanishes following a regulatory change in the deposit limit. These findings are consistent with a significant too-big-to-fail subsidy paid to the largest banks through lower risk premiums on uninsured deposits.
Does Regulatory Bank Oversight Impact Economic Activity? A Local Projections Approach by Vivian Hwa, Pavel Kapinos, and Carlos Ramirez. Journal of Financial Stability, December 2018, Volume 39, 167-174.
Existing research generally finds that the magnitude of the effect of supervisory rating shocks on real economic activity is small and short-lived. Theoretical work on this topic is also limited. This paper addresses both issues. First, we develop a model that combines a signal extraction problem with a costly adjustment of a policy instrument to demonstrate that bank supervisory changes can be decomposed into a “systematic” component (driven by fundamental banking and macroeconomic shocks) and a “non-systematic” component (driven by shifts in uncertainty). Second, we use the local projections approach to estimate impulse responses from a vector autoregression (VAR) model. We show that the effect of supervisory stringency shocks is larger than the one estimated with the standard Cholesky structural VAR approach. We find that the effects are asymmetric: bank downgrades lead to a pronounced decline in real activity, while upgrades do not result in its increase. The linear framework averages out these effects, overstating the impact of upgrades, and understating that of downgrades. Furthermore, we document the presence of nonlinear effects for the downgrade shocks, as their impact increases disproportionately with its size. Such effects are not observed for upgrade shocks. Finally, we demonstrate that our results are robust to the inclusion of a variety of controls.
Measurement Error in Residential Property Valuation: An Application of Forecast Combination by Dennis Glennon, Hua Kiefer, and Tom Mayock. Journal of Housing Economics, September 2018, Volume 41, 1-29.
In this study we use a large database of real estate transactions to assess the magnitude of measurement error associated with using popular house price indices (HPIs) to value individual properties. In the 4 large U.S. counties that we analyze, we find that the bias associated with using these HPIs to value individual homes increased from near zero in 2005 to between 26% and 113% in 2010. In the second part of the analysis, we use data from Florida to demonstrate that forecast combination methods can be used to improve the accuracy of property-level valuations, in some cases reducing the estimated bias by more than a factor of 3. We find that even the simplest forecast combination method – a simple average – has the potential to significantly improve value estimates.
Short Termism of Executive Compensation by Jon Pogach. Journal of Economic Behavior & Organization, April 2018, Volume 148, 150-170.
I present an optimal contracting theory of short term firm behavior. Contracts inducing short sighted managerial behavior arise as shareholders' response to conflicting intergenerational managerial incentives. High return projects may be longer lived than the tenure of managers who implement them. Consequently, inducing managers to act in the long term interests of the firms requires the alignment of incentives across multiple managers. This comes at greater costs than providing incentives for a single manager thereby leading to short term incentive contracts. Long term firm value maximization is further impeded when only the returns of accepted projects are public and not those of declined projects. In that case, shareholders find it costly to induce long term project selection among managers who can earn all information rents from short term projects but must sacrifice information rents from long term projects to future managers.
CFR Working Paper 2016-01.
Spillover Effects in Home Mortgage Defaults: Identifying the Power Neighbor by Souphala Chomsisengphet, Hua Kiefer, and Xiaodong Liu. Regional Science and Urban Economics, November 2018, Volume 73, 68-82.
This paper investigates spillover effects of mortgage defaults in the neighborhood on a homeowner's default decision. Following the interactions-based model of discrete choices in Lee et al. (2014), we explicitly model a homeowner's default decision as a function of predetermined risk factors as well as rational expectations on her neighbors' default decisions and find strong empirical evidence of spillover effects — in forms of time-lagged “contagion effects” and contemporaneous “multiplier effects”. Furthermore, the estimated model can be used to identify the “power neighbor” through whom a foreclosure prevention policy can generate the largest impact on a neighborhood. Compared to other homeowners, the “power neighbor” on average has less neighbors that defaulted in the past, a less risky loan, a smaller payment size, a higher credit score, and a more central location in the neighborhood.
Determining the Target Deposit Insurance Fund: Practical Approaches for Data-Poor Deposit Insurers by John O'Keefe and Alex Ufier. World Bank Group, FIRST Initiative, November 2017.
In order for deposit insurers to be able to maintain public confidence following a bank failure, they must be able to act quickly to repay depositors and adequately fund the resolution of failed institutions. According to the International Association of Deposit Insurers, the best measure of deposit insurer funding adequacy is the Target Fund Ratio, the deposit insurance fund divided by total insured deposits, and each countries fund target will vary based on institutional needs. This paper presents a framework to assist countries, especially data-poor ones, in developing such a funding target. The paper employs a simulation approach that combines probability of default, loss given default, default correlation, and exposure at default to yield Target Fund Ratios required for the deposit insurer to remain solvent across a variety of different economic environments. This paper then uses the U.S. as an example country and compares results of the method to U.S. experiences and policy decisions.
CFR Working Paper 2017-04.
Does Bank Supervision Impact Bank Loan Growth? by Paul Kupiec, Claire Rosenfeld, and Yan Lee. Journal of Financial Stability, February 2017, Volume 28, 29-48.
We estimate the impact of a poor bank examination rating on the growth rates of individual bank loan portfolios. We use a novel approach to control for loan demand variation and estimate a fixed-effect model using an unbalanced panel with over 381,000 bank-quarter observations from the period 1994-2011. Our estimates show that a poor examination rating has a large negative impact on bank loan growth, even after controlling for the impact of monetary policy, bank capital and liquidity conditions, and any voluntary reduction in lending triggered by weak legacy loan portfolio performance or other bank losses. This previously unidentified effect is consistent with the hypothesis that the bank supervision process successfully constrains the lending activities of banks operating in an unsafe and unsound manner.
Firm Default Prediction: A Bayesian Model Averaging Approach by Jeffery Traczynski. Journal of Financial and Quantitative Analysis, June 2017, Volume 52, Issue 3, 1211-1245.
I develop a new predictive approach using Bayesian model averaging to account for incomplete knowledge of the true model behind corporate bankruptcy. I find that uncertainty over the correct model is empirically large, with far fewer variables being significant predictors of bankruptcy compared to conventional approaches. Only the ratio of total liabilities to total assets and the volatility of market returns are robust bankruptcy predictors in the overall sample and in all industry groups. Model averaged bankruptcy forecasts that aggregate information across models or allow for industry specific effects substantially outperform individual models.
Small Businesses and Small Business Finance During the Financial Crisis and the Great Recession: New Evidence from the Survey of Consumer Finances by Arthur Kennickell, Myron Kwast, and Jon Pogach. Chapter in NBER book Measuring Entrepreneurial Businesses: Current Knowledge and Challenges, September 2017, 291-349.
We use the Federal Reserve’s 2007, 2009 re-interview of 2007 respondents, and 2010 Surveys of Consumer Finances (SCFs) to examine the experiences of small businesses owned and actively managed by households during these turbulent years. This is the first paper to use these SCFs to study small businesses even though the surveys contain extensive data on a broad cross-section of firms and their owners. We find that the vast majority of small businesses were severely affected by the financial crisis and the Great Recession, including facing tight credit constraints. We document numerous and often complex interdependencies between the finances of small businesses and their owner-manager households, including a more complicated role of housing assets than has been reported previously. We find that workers who lost their job responded in part by starting their own small business, and that factors correlated with the survival of a small business differed greatly depending upon whether the firm was established or new. Our results strongly reinforce the importance of relationship finance to small businesses, and the primary role of commercial banks in such relationships. We find that both cross-section and panel data are needed to understand the complex issues associated with the creation, survival and failure of small businesses.
CFR Working Paper 2015-04.
The Effect of Foreign Lending on Domestic Loans: An Analysis of US Global Banks by Edith Liu and Jon Pogach. Economic Letters, July 2017, Volume 156, 151-154.
This paper examines the effect of foreign lending on the domestic lending for US global banks. We show that greater foreign loan growth complements—rather than detracts—from domestic commercial lending. Exploiting a confidential dataset (FFIEC 009) on international loan exposure of US banks, we estimate that a 1% increase in foreign office lending growth is associated with a 0.6% increase of domestic industrial lending growth, which suggests potential complementarities across banking products.
A Reexamination of Stock Return Predictability by Yongok Choi, Stefan Jacewitz, and Joon Park. Journal of Econometrics, May 2016, Volume 192, Issue 1, 168-189.
Much of the existing empirical literature finds that stock returns are not only predictable, but highly so. We approach this old question from a completely new direction, proposing an innovative and effective test of predictability in stock returns. When we apply our new technique to the data, we find no evidence supporting stock return predictability, at least if we use the common predictive ratios such as dividend-price and earnings-price ratios. We show that certain data characteristics that are ubiquitous and widely accepted, such as the persistency of common predictive ratios and the presence of stochastic volatility in stock returns, have a substantial impact on traditional hypothesis testing. Our new technique for testing predictability is uniquely suited to these characteristics of predictive regression data. The technique consists of a simple time change to volatility time to accommodate a quite general form of stochastic volatility in stock returns and instrumental variable estimation to allow for a wide range of endogenous nonstationary covariates. We provide Monte Carlo evidence to show that our methodology performs well in terms of both size and power.
Nigeria: A Methodological Approach for Development of a Target Deposit Insurance Fund Model by John O'Keefe and Alex Ufier. World Bank Group, FIRST Initiative, May 2016.
This report is part of a World Bank technical assistance project with the Nigeria Deposit Insurance Corporation (NDIC). The purpose of the assistance was to develop a model for the target deposit insurance fund ratio for Nigeria. The paper develops a loss distribution for the NDIC using Monte Carlo simulations and determines an appropriate target fund level based on the NDIC’s risk appetite. Bank PD, EAD, LGD and failure correlation parameters are estimated using historical data from Nigerian bank financial statements, CAMELS ratings and NDIC losses.
Should we Fear the Shadow? House Prices, Shadow Inventory, and the Nascent Housing Recovery by Hua Kiefer. The Journal of Real Estate Finance and Economics, April 2016, Volume 52, Issue 3, 272-321.
Although a broad-based increase in house prices has been observed over the past year, not everyone is convinced the rise of house prices will persist and lead to a steady recovery of the economy. The main reason for this skepticism is uncertainty about the "shadow inventory" foreclosed homes held by investors or as REOs, which have not yet hit the market but likely will as market prices rise. The volume of shadow inventory itself in local markets is largely unknown, as is its impact on the housing market. This study quantifies the size of the shadow inventory and investigates the spatial impact of the out-flow of shadow inventory. The scope of our study is a set of housing markets (AZ, CA, and FL) that vary in both their historic housing price volatility as well as institutional factors - such as foreclosure law statues - that may influence the relationship between the shadow inventory and house price dynamics. To address the endogeneity that characterizes the spatial interaction of house prices and the out-flow of the shadow inventory, we utilize a simultaneous equation system of spatial autoregressions (SESSAR). The model is estimated using measures of the shadow inventory derived from DataQuick's national transaction history database and county-level house price indices provided by Black Knight. Lastly, because our estimate - as well as all other existing estimates - of the shadow inventory relies upon string matching algorithms to identify entry into and exit out of REO status, we validate the accuracy of our measures of REOs using loss mitigation data from the OCC Mortgage Metrics database.
Zimbabwe: A Methodological Approach for Development of a Target Deposit Insurance Fund Model by John O'Keefe and Alex Ufier. World Bank Group.
This report is part of a World Bank technical assistance project with the Deposit Protection Corporation (DPC) of Zimbabwe. The purpose of the assistance was to develop a model for the target deposit insurance fund ratio for Zimbabwe. The paper develops a loss distribution for the DPC using Monte Carlo simulations and determines an appropriate target fund level based on risk appetite. Bank PD, EAD, LGD and failure correlation parameters are estimated using historical data from bank financial statements, CAMELS ratings and losses.