Capital Openness and Financial Crises: A Financial Contagion Model with Multiple Equilibria

Abstract

This paper explores the effects of capital openness on financial crises and contagion. In the model, we analyze four channels of contagion involved in the process of financial crisis: monsoon effects, spillovers, self‐fulfilling expectations and new information. We empirically test the data from China, an economy with capital account controls, and find that the fundamentals of China (PRC) are now in a vulnerable area which yields multiple equilibria. Consequently, the Chinese economy is easily affected via the channels discussed in this paper. Finally we suggest that the capital account of China should be opened gradually.     

RACIAL BELIEFS,LOCATION, AND THE CAUSES OF CRIME*

This article provides a unified explanation for why blacks commit more crime, are located in poorer neighborhoods, and receive lower wages than whites. If everybody believes that blacks are more criminal than whites—even if there is no basis for this—then blacks are offered lower wages and, as a result, locate further away from jobs. Distant residence increases even more the black–white wage gap because of more tiredness and higher commuting costs. Blacks have thus a lower opportunity cost of committing crime and become indeed more criminal than whites. Therefore, beliefs are self‐fulfilling.     

Can individuals’ beliefs help us understand nonadherence to malaria test results? Evidence from rural Kenya

In malaria‐endemic countries about a quarter of test‐negative individuals take antimalarials (artemisinin‐based combination therapies [ACTs]). ACT overuse depletes scarce resources for subsidies and contributes to parasite resistance. As part of an experiment in Kenya that provided subsidies for rapid diagnostic test and/or for ACTs conditionally on being positive, we studied the association between beliefs on malaria status (prior and posterior the intervention) and decisions to get tested and to purchase ACTs. We find that prior beliefs do not explain the decision of getting tested (conditional on the price) and nonadherence to a negative test. However, test‐negative individuals who purchase ACTs report higher posterior beliefs than those who do not, consistent with a framework in which the formers revise beliefs upward, while the latters do not change or revise downward. We also do not find evidence that prior beliefs on ACT effectiveness and trust in test results play any major role in explaining testing or treatment behavior. Further research is needed to improve adherence to malaria‐negative test results.     

THE IMPACT OF INSURANCE SUBSIDIES ON SELF‐EMPLOYMENT: DO STATE NON‐GROUP HEALTH INSURANCE REGULATIONS MATTER?

This paper tests whether the effect of tax‐based subsidies for self‐employed health insurance on the level of self‐employment differs with the type of non‐group insurance regulatory regime at the state level. Using a panel of tax returns from 1999 to 2004, we estimate fixed effects instrumental variable regressions for the probability of being self‐employed, allowing the effect of the after‐tax price of self‐employed health insurance to differ by regulatory regime. Our results suggest that states with community rating and guaranteed issue regulations had significantly smaller increases in the fraction of taxpayers reporting some amount of self‐employment income as a result of a decrease in the after‐tax price of self‐employed health insurance. However, there is suggestive evidence that heavily regulated states experienced a larger increase in exclusive self‐employment, particularly among older taxpayers. (JEL J24, H24, I18)     

LATIN AMERICAN EXCHANGE RATE DEPENDENCIES: A REGULAR VINE COPULA APPROACH

This study implements a regular vine copula methodology to evaluate the level of contagion among the exchange rates of six Latin American countries (Argentina, Brazil, Chile, Colombia, Mexico, and Peru) from June 2005 to April 2012. We measure contagion in terms of tail dependence coefficients, following Fratzscher's (1999) definition of contagion as interdependence. Our results indicate that these countries are divided into two blocks. The first block consists of Brazil, Colombia, Chile, and Mexico, whose exchange rates exhibit the largest dependence coefficients, and the second block consists of Argentina and Peru, whose exchange rate dependence coefficients with other Latin American countries are low. We also found that most of the Latin American exchange rate pairs exhibit asymmetric behaviors characterized by nonsignificant upper tail dependence and significant lower tail dependence. These results imply that there exists contagion in Latin American exchange rates in periods of large appreciations, whereas there is no evidence of contagion during periods of currency depreciation. This empirical regularity may reflect the “fear of appreciation” in emerging economies identified by Levy‐Yeyati, Sturzenegger, and Gluzmann (2013). (JEL C32, C51, E42)     

Self‐Fulfilling Early‐Contracting Rush*

In markets for entry‐level professionals, the insurance motive drives some participants to sign early contracts. The rush to early contracting can be self‐fulfilling, as both its effect on expectations about demand–supply balance in the subsequent spot market and the effect on it from changes in the demand–supply balance can be nonmonotone. Matching markets with more risk‐averse participants, a greater uncertainty regarding relative supply of positions, or a more polarized distribution of applicant qualities are more vulnerable to self‐fulfilling early‐contracting rushes. Employers can have a collective interest in preventing early offers to a few promising applicants from starting the rushes.     

The Asian Currency Crises: Vulnerability, Contagion, or Unsustainability

The Asian currency crises have been introduced by many economists as evidence that almost any country could be vulnerable to speculative attacks and to contagion effects, even with apparently good economic fundamentals. These financial crises have also been interpreted by other economists as rational market reactions to the unsustainability of domestic macroeconomic policies or structural weaknesses. The objective of this paper is to evaluate the relative importance of macroeconomic unsustainability, financial vulnerability, and crisis contagion in a model that explains and predicts the Asian currency crises. Out-of-sample forecasts based on two-stage panel and logit regressions provide evidence of a pure contagion effect, which significantly worsened the crises. They also show that Indonesia was the only one of the six Asian nations examined (India, Indonesia, Malaysia, Philippines, South Korea, Thailand) that was in an unsustainable economic situation, and that the other five nations were only vulnerable to a currency crisis.     

On the Evolution of Pareto‐Optimal Behavior in Repeated Coordination Problems

I characterize the asymptotic behavior of a society facing a repeated‐common‐interest game. In this society, new individuals enter to replace their “parents” at random times. Each entrant has possibly different beliefs about others' behavior than his or her predecessor. A self‐confirming equilibrium (SCE) belief process describes an evolution of beliefs in this society consistent with a self‐confirming equilibrium of the repeated game. The main result shows that for any common‐interest game, the Pareto‐dominant equilibrium is a globally absorbing state of the behavioral dynamics when the SCE beliefs of new entrants satisfy certain independence and full‐support properties. This result does not involve either of the usual assumptions of myopia or large inertia common in evolutionary models, nor is this result possible if only Nash rather than self‐confirming equilibria are considered.     

A MODEL OF SELF‐FULFILLING FINANCIAL CRISES*

This paper combines the structural weakness and the self‐fulfilling panic view to explain the cause of the East Asian crises. In this model economy, the diversification strategies induce conglomerate firms to overinvest. They accumulate losses due to their unprofitable sectors and then compensate by obtaining bank loans. Domestic banks, which borrow from foreign banks, lend money as long as the total amount of accumulated loans remains within the firms’ collateral value. The model shows that if the debt to collateral value ratio belongs to a certain range a self‐fulfilling crisis can occur due to the self‐fulfilling expectations of foreign investors.     

TAXES,HEALTH INSURANCE,AND WOMEN'S SELF‐EMPLOYMENT

I examine whether the availability of health coverage through the spouse's health plan influences a married woman's decision to become self‐employed. The Tax Reform Act of 1986 (TRA86) introduced a tax subsidy for the self‐employed to purchase their own health insurance. I test whether this “natural” experiment induced more women without spousal health insurance coverage to select into self‐employment. The most conservative difference‐in‐difference estimates based on an analysis of employed women indicate that the incidence of self‐employment among single women rose by 10% in the post‐TRA86 period, while a multinomial specification based on a sample of both employed and nonemployed women suggests that the increase was about 13%. (JEL J0, J3, I1)     

The Governance of a Fragile Eurozone

When entering a monetary union, member countries change the nature of their sovereign debt in a fundamental way; that is, they cease to have control over the currency in which their debt is issued. As a result, financial markets can force these countries’ sovereigns into defaulting. This makes the monetary union fragile and vulnerable to changing market sentiments. It also makes it possible that self‐fulfilling multiple equilibria arise. I analyse the implications of this fragility for the governance of the Eurozone. I argue that the role of the European Central Bank as a lender of last resort is crucial in reducing the fragility of the Eurozone. In addition, steps towards a budgetary union are key in structurally strengthening the union.     

LONGER‐RUN EFFECTS OF ANTI‐POVERTY POLICIES ON DISADVANTAGED NEIGHBORHOODS

We assess evidence on the longer‐run effects of minimum wages, the Earned Income Tax Credit, and welfare on key economic indicators of economic self‐sufficiency in disadvantaged neighborhoods. The evidence suggests that the longer‐run effects of the Earned Income Tax Credit are to increase employment and to reduce poverty and public assistance. We also find some evidence consistent with higher welfare benefits having longer‐run adverse effects, and stronger evidence that tighter welfare time limits reduce poverty and public assistance in the longer‐run. The evidence on the longer‐run effects of the minimum wage on poverty and public assistance is not robust. (JEL J22, J23, J38)     

Transition welfare gaps: One closed,another to follow?

Respondents from post‐communist countries have been found to systematically report lower levels of happiness and self‐rated health. While the first welfare gap in happiness has closed recently, the second transition gap in self‐perceived health only started to close. Specifically, this paper shows that treating all transition countries as a homogeneous group may be misleading and therefore divides 28 transition countries into three groups. As a result, in the most recent 2016 round of the ‘Life in Transition’ survey, transition countries in Southern Europe are no longer found to be different from non‐transition nations in terms of their self‐rated health. Although the gap in self‐perceived health for transition nations in Eastern Europe is present in a basic model, it becomes less statistically and economically significant when subjective beliefs and macro‐level variables are added. Countries from the former Soviet Union and Mongolia remain the only group in which respondents report 16.5%–29.1% lower probability of ‘Good’ or ‘Very Good’ health compared to other transition and non‐transition countries. Controlling for communist party membership, ideological beliefs and macro‐level variables somewhat reduces the gap for the former Soviet Union and Mongolia but it remains significant in multiple robustness checks. Although the gap in self‐rated health now applies to only one group of transition countries, it remains an important empirical puzzle with far‐reaching implications for health policy, demand for healthcare and the process of transition.     

DO MANAGERS MATTER: EVIDENCE FROM E‐SPORTS

Growing importance of human resources places the role of managers at the core of company efficiency. However, there are studies that demonstrate the efficiency of teams without a manager, so‐called self‐managed teams, is higher comparing with managed teams. Thus, despite the focus on managerial efficiency in the economic literature, the issue of whether a team needs a manager is far from settled. In this paper, we use a quasi‐experimental setting from e‐Sports (competitive video gaming) to understand whether the hiring a manager is of benefit to team performance. The empirical part of the study is based on endogenous switching regression model. This method allows investigating what performance of self‐managed team would be if it will have a manager and vice versa. The dataset includes the information of prize money and features of top e‐Sports teams in Counter‐Strike: Global Offensive (e‐Sports discipline) from 2013 to 2017. The main finding of this study is that managed teams perform better than self‐managed ones but this is not due to the manager. (JEL Z2, M54, L25)     

Income or Consumption: Which Better Predicts Subjective Well‐Being?

The positive relationship between income and subjective well‐being has been well documented. However, work assessing the relationship of alternative material well‐being metrics to subjective well‐being (SWB) is limited. Consistent with the permanent income hypothesis, we find that a consumption‐based measure out‐performs (surveyed) income in predicting subjective well‐being. When objective measures of consumption are combined with self‐assessments of a household’s standard of living, income becomes insignificant altogether. We obtain our result utilizing household‐level data from Statistics New Zealand’s New Zealand General Social Survey which contains measures of income, SWB and a measure of material well‐being called the Economic Living Standard Index that combines measures of consumption flows and self‐assessments of material well‐being.     

Ideological spillovers across the Atlantic? Evidence from Trump's presidential election

Ideological spillovers refer to the modification of an individual's core beliefs after learning about other people's beliefs. We study one specific international ideological spillover, namely, the effect of the unexpected election of a United States (US) president (Donald Trump on the 9^th of November 2016), who openly questioned the so-called ‘core liberal consensus’, on European's core political beliefs. Using a regression discontinuity design (RDD) around the election event, we show that the Trump presidential election (TPE) gave rise to a ‘backlash effect’. That is, it steered core European beliefs in two specific domains, making Europeans more favourable to (i) globalisation and (ii) international mobility (about 10% change in the overall Likert scale range of the statement that immigrants contribute to a country). Contrasting with the hypotheses of ‘belief contagion’, we do not find evidence that TPE steered illiberal beliefs. Furthermore, TPE improved (deteriorated) the view Europeans had of their own country (the United States).     

MODELING THE INCIDENCE OF SELF‐EMPLOYMENT: INDIVIDUAL AND EMPLOYMENT TYPE HETEROGENEITY

Modeling the incidence of self‐employment has traditionally proved problematic. Although the supply‐side characteristics of the self‐employed are well documented, we argue that the literature has neglected demand‐side aspects. We explore the determinants of self‐employment using the U.S. Survey of Consumer Finances. We present results from an econometric framework that allows us to model, separately and simultaneously, the influences of individual heterogeneity (i.e., supply‐side factors) and employment type heterogeneity (i.e., demand‐side factors) on the probability of self‐employment. Our findings suggest that while individual characteristics are important determinants of self‐employment, there are factors specific to the type of employment that influence self‐employment. (JEL J23, J33, C25, C10)     

Does transition make you happy?1

This paper analyses life satisfaction in transition countries using evidence from the World Values Survey. The paper demonstrates that individuals in transition economies on average record lower values of self‐reported satisfaction with life compared with those in non‐transition countries. A comparison across time for a smaller sample of countries shows that life satisfaction levels have returned close to pre‐transition levels in most cases, after a dip in the mid‐1990s. The socio‐economic groups that exhibit relatively higher levels of happiness include students, people with higher levels of education and those on higher incomes. Happiness declines with age until the early‐50s and is slow to recover afterwards. Self‐employed people in transition countries show a level of satisfaction as high as, or higher than, full‐time employees, in contrast to evidence from non‐transition countries. In addition, satisfaction levels are highest in those countries where standards of economic governance are most advanced and where inequality is lower.     

Safe haven or contagion? The disparate effects of Euro-zone crises on non-Euro-zone neighbours

While there have been many studies that examine contagion within the Euro-zone, this article investigates the potential contagion from changes in the Greek sovereign risk premium over 2009–2016, as measured by the yield on 10-year government bonds, to six European countries outside of the Euro-zone all of which operated a managed float against the Euro. We find evidence of contagion to potential Euro-zone ascendants (Czech Republic, Hungary and Poland), but ‘flight to safety’ (or safe haven) effects for the United Kingdom, Sweden and Switzerland.