An experimental study of precautionary bidding

Auctions often involve goods exhibiting a common-knowledge ex-post risk. In such auctions, precautionary bidding predicts that under expected utility, DARA bidders reduce their bids by more than the appropriate risk premium. Because the degree of riskiness of an auctioned good and bidders׳ levels of risk aversion are difficult to observe in field settings, we conduct experimental auctions that allow us to identify the precautionary premium directly. We find strong evidence for precautionary bidding. The effect is robust to changes in experimental design features. Our experiment provides the first empirical demonstration of precautionary motives in a strategic setting.     

Uncovered interest parity in Central and Eastern Europe: Expectations and structural breaks

This paper examines the empirical validity of the hypothesis of uncovered interest parity (UIP) using data from five Central and Eastern European countries with floating exchange rates for the period 2003 to 2014. The analysis includes forward‐looking as well as static expectations and allows for different types of structural break. The variable depicting the deviation from strict UIP is stationary when expectations are forward looking, suggesting that it is not possible to reject the UIP hypothesis with a constant risk premium. The deviation from strict UIP is however typically not stationary when expectations are static, even when structural breaks are incorporated, leading to the rejection of the UIP hypothesis with a constant risk premium. The results underscore the central role of expectations for the UIP hypothesis.     

Uncovered Interest Parity at Long Horizons: Evidence on Emerging Economies*

This paper estimates uncovered interest parity (UIP) at long horizons using bilateral US dollar rates vis‐à‐vis mature economy and emerging market currencies. The paper finds support in favor of UIP for dollar rates vis‐à‐vis major mature economy currencies, but far less against emerging market currencies. There are also signs that political risk and the exchange risk premium help explain the empirical failure of UIP for these latter currencies. This suggests that whether UIP holds depends more on the currency than on the horizon.     

Do mispricing and financial constraints matter for investment decisions?

This study investigates how mispricing and financing constraints affect ?rms’ future capital investments. We find that when the financing constraints are high, overpriced (underpriced) firms invest more (less) subsequently under previous non-optimal investments. The overpriced (underpriced) firms with precautionary motives invest significantly less subsequently when they are financially constrained. The overall evidence suggests that share mispricing, financial constraints and precautionary motives play a critical role that enables investors to less effectively monitor managers’ real decisions, thus limiting firms’ capital investments.     

Uncovered interest parity and risk premium convergence in Central and Eastern European countries

This study applies non-linear threshold unit-root test to investigate the non-stationary properties of the uncovered interest parity (UIP) with risk premium for ten Central and Eastern European (CEE) countries. We find that non-linear threshold unit-root test has higher power than linear method suggested by Caner and Hansen (2001) if the true data generating process of risk premium convergence is in fact a stationary non-liner process. We examine the validity of UIP from the non-linear point of view and provide robust evidence clearly indicating that UIP holds true for seven countries. Our findings point out that capital mobility and exchange market efficiency are in these CEE countries with non-linear way.     

CORPORATE CASH HOLDINGS AND CREDIT LINE USAGE

We investigate the factors driving the unprecedented rise in corporate liquidities since the 1970s. We find that an economy‐wide reduction in the cost of holding liquidities and an increase in risk best explain the rise in cash holdings and the widespread use of credit lines. The structural estimation results shed light on two widely acknowledged motives for holding cash. The precautionary motive and the liquidity motive translate risk exposure into cash holdings. Our results, however, do not suggest that firms have become more prudent over time. It is higher liquidity needs that has forced firms to hold more cash and use more credit lines.     

On the Joint Test of the Uncovered Interest Parity and the Ex‐ante Purchasing Power Parity

This study revisits the relation between the uncovered interest parity (UIP), the ex‐ante purchasing power parity (EXPPP) and the real interest parity (RIP) for the UK and Japanese vs US data. The original contribution is on developing some joint coefficient‐based tests, obtained by rewriting the UIP, the EXPPP and the RIP as a set of cross‐equation restrictions in a vector autoregression (VAR) framework. Test results point to a “forward premium” bias in both the UIP and the EXPPP. The latter result is novel in the literature and stems from testing the PPP in expectational terms. Moreover, the results suggest a currency‐dependent pattern for the UIP, contrarily to the EXPPP equation. Finally, it is shown that conditioning the VAR on M3 growth differential has important explanatory power in resolving the aforementioned biases in both the UIP and EXPPP equations for the UK vs US data. At the same time, variables having a strong forward‐looking component (i.e. share prices) help recover a unitary coefficient in the UIP equation.     

Estimating the demand for reserve assets across diverse groups of countries

This paper takes a fresh look at the determinants of the holding of reserves with the aim of highlighting similarities and differences among emerging markets (EMs), advanced economies (AEs), and low‐income countries (LICs). We apply two panel estimation techniques: fixed effects (FE) and common correlated effects pooled mean group (CCEPMG). FE regression results suggest that precautionary savings’ motives, both current account‐ and capital account‐related, are generally the most important determinants of reserves’ holding for all country groups. Nonetheless, there is considerable heterogeneity across country groups and over time. The intertemporal motive, a novelty of this paper, has gained importance everywhere. The CCEPMG results confirm the importance of precautionary motives and suggest that current account motives matter only for EMs and LICs and capital account motives matter for all groups while being more relevant for EMs. The CCEPMG results also point to the importance of taking into account the heterogeneous impact of unobserved common factors that affect coefficient estimates and the dynamic process through which reserves adjust to changes.     

Bequest Motives and the Demand for Life Insurance in East Germany

Empirical studies of household saving remain inconclusive about the role of bequest motives. This may be due to the diluting effect of different tax regimes across countries and time on estimates of bequest motives. Relative to market‐based economies, the former German Democratic Republic can be viewed as an experimental institutional setting where life‐insurance demand was not influenced by tax considerations. This allows isolating bequest motives from other life‐cycle and precautionary savings motives. Analyzing the demand for life insurance, we find a significantly higher ownership probability among households with children and a high regard for the family, confirming bequest motives in life‐insurance demand.     

Pension Plan Funding,Technology Choice,and the Equity Risk Premium

In this paper, the impact of Lazear contracts with defined‐benefit pensions on aggregate technology composition and the aggregate risk premium is examined. In the presence of capital market constraints affecting workers, defined‐benefit pensions bias the economy towards risk‐free production. Leveraging the risky technology relaxes the constraints and results in more risky production and a fall in the aggregate risk premium. This effect holds with risky debt and low pension shortfall risk but breaks down with high pension shortfall risk. A key prediction is that as Lazear contracts become less common, risky production will increase and the aggregate risk premium will fall.     

Precautionary saving under liquidity constraints: Evidence from rural Pakistan

This paper investigates precautionary saving under liquidity constraints in Pakistan using household panel data. In particular, while it estimates Kimball's [Kimball, M.S. Precautionary saving in the small and in the large. Econometrica 1990; 58; 53–73.] prudence parameter based on a framework that is similar to Dynan [Dynan, K.E. How prudent are consumers? Journal of Political Economy 1993; 101; 1104–1113.], this study deviates from the framework by explicitly considering liquidity constraints, as in Zeldes [Zeldes, S.P. Consumption and liquidity constraints: an empirical investigation. Journal of Political Economy 1989; 97; 305–346.]. By doing so, this paper attempts to differentiate the standard precautionary saving caused by uncertainty from that caused by liquidity constraints. Furthermore, endogenous liquidity constraints are used in order to resolve issues of selection biases. We find substantial evidence of the presence of precautionary saving in Pakistan. More specifically, the estimated prudence is significantly higher for liquidity-constrained households as compared with unconstrained ones. The finding suggests that the precautionary saving motives appear stronger when households see that their access to credit markets is limited.     

Downward nominal wage rigidity in Canada: Evidence against a “greasing effect”

The existence of downward nominal wage rigidity (DNWR) has often been used to justify a positive inflation target. It is traditionally assumed that positive inflation could “grease the wheels” of the labour market by putting downward pressure on real wages, easing labour market adjustments during a recession. A rise in the inflation target would attenuate the long‐run level of unemployment and hasten economic recovery after an adverse shock. Following Daly and Hobijn (2014), we re‐examine these issues in a model that accounts for precautionary motives in wage‐setting behaviour. We confirm that DNWR generates a long‐run negative relationship between inflation and unemployment, in line with previous contributions to the literature. However, we also find that the increase in the number of people bound by DNWR following a negative demand shock rises with the inflation target, offsetting the beneficial effects a higher inflation target has on closing the unemployment gap. As an implication, contrary to previous contributions that neglected precautionary behaviour, the speed at which unemployment returns back to pre‐crisis levels during recessions is relatively unaffected by variations in the inflation target.     

Uncovered Interest Parity: Cross‐Sectional Evidence

Uncovered interest parity (UIP) is estimated for short‐term horizons from one month to 12 months using a large number of cross‐sectional bilateral exchange rates. In contrast to conventional time‐series UIP, cross‐sectional UIP is examined with a single‐equation estimation and panel regression model estimation. The exchange rates analyzed here include a broad spectrum of countries: developed, developing, low‐inflation, and high‐inflation countries. Based on the empirical evidence, there does not appear to be a well‐publicized UIP puzzle for cross‐sectional UIP, and the slope estimates remain largely between zero and one throughout the sample periods, with a few exceptions. Evidence of UIP is more clear for low inflation countries than for high inflation countries. As interest rate maturity becomes longer from one month to 12 months, the UIP relationship becomes weaker.     

Analysing the risk premium in the Italian stock market: ARCH-M models versus non-parametric models

This Paper investigates the variability of the risk premium in the Italian stock market, over the period 1978–89. We have modelled voatility using two different approaches: ARCH-M models and non-parametric models. The estimate of the ARCH-M models confirm the existence of both an ARCH process in the variance and a time-varying risk premium. Also the non-parametric specification confirms the existence of a time varying risk premium. Moreover in both models the acceleration in the inflation rate has a negative effect on stock prices.     

TESTING UNCOVERED INTEREST PARITY: A CONTINUOUS‐TIME APPROACH*

Nowadays researchers can choose the sampling frequency of exchange rates and interest rates. If the degree of overlap is large relative to the sample size, standard GMM asymptotic theory provides unreliable inferences in uncovered interest parity (UIP) regression tests. We specify a continuous‐time model for exchange rates and forward premia robust to temporal aggregation, unlike existing discrete‐time models. We test the UIP restrictions on the continuous‐time model parameters and propose a novel specification test that compares estimators at different frequencies. Our results based on correctly specified models provide little support for UIP at both short and long horizons.     

Equality of interest rates revisited: the multi‐country evidence

One influential aspect of international integration of financial markets is the possibility of reducing divergences between domestic interest rates and foreign interest rates or increasing the degree to which yields in different financial markets move together over time. In this study, we investigate the convergence of the real interest rates using the Kalman filter. Applying the modified Hall et al. () approach, we model the risk premium and convergence of real interest rates using the time‐varying parameter estimation techniques. We present evidence of risk premium and convergence for two blocks of countries—The Asian‐Pacific countries including the US, Japan, Taiwan and South Korea and the US‐European group including France, the UK, Germany and the US.     

Forward-premium puzzle: is it time to abandon the usual regression?

The forward premium puzzle is usually evidenced by the rejection of the null hypothesis in the uncovered interest parity (UIP) regression. Because this parity need only hold in a risk-neutral world, a risk adjustment term is missing from the equation if speculation in foreign exchange markets is risky. We deal with this issue following the literature which assumes that discounted returns on foreign government bonds are log-normal, so we can linearize the Euler pricing equations (in level) and obtain a modified UIP system for which the risk adjustment term is obtained by applying to the pricing kernel-based relations a generalized autoregressive conditional heteroscedasticity-in-mean model. However, here we innovate by adopting a methodology which differs from all these related works. We construct and use a stochastic discount factor that does not depend on a specific model, by residing in the space of returns which we extract from the data by simply imposing the orthogonality restrictions represented by the Euler equations. So, we devise a purely statistical pricing kernel that performs well in in-sample level equations. Somewhat disappointingly, the risk premium inclusion in the conventional regression changes neither the significance nor the magnitude of the forecasting power of the forward premium for most currencies we study. The contrasting performance of the tests in level and in logs suggests that linearization may be to blame.     

Precautionary saving in the presence of other risks

Does the sign of the third derivative of the utility function with respect to wealth still govern precautionary saving motives in the presence of a background risk? This article shows that some other properties of the utility function have also to be considered depending on the serial correlation existing between the background risk and the future income risk.     

WAGE VOLATILITY AND CHANGING PATTERNS OF LABOR SUPPLY

Over the past few decades, the skilled–unskilled hours differential for U.S. men increased when the skill premium rose sharply, in contrast with dominant income effects. Based on PSID data, we show that over the 1967–2000 period, skilled men experienced a three times larger increase in wage volatility than unskilled men. With the rise in wage volatility, our general equilibrium incomplete markets model generates a 2.7 hours increase in the hours differential whereas it increased by 1.4 hours in the data. We find that hours adjustments are important for self‐insurance in the short run, whereas precautionary savings play a crucial role eventually.     

Collateral premia and risk sharing under limited commitment

A competitive general equilibrium model with complete collateralized contracts under limited commitment is proposed and analyzed. With limited aggregate collateral, risk sharing is imperfect. There exists a minimal spanning set of finite collateralized contracts that generates the feasible space and that contains more than the complete set of collateralized Arrow securities. Examples show that exogenously restricting feasible contracts has a significant impact on agents’ welfare. I prove that constrained optimal allocations can be decentralized as a general equilibrium with collateral constraints, and vice versa. Because a capital good serves as collateral, it has an additional value, called collateral premium. The collateral premium is zero if and only if risk sharing is perfect. This is a testable implication of the model.