Public Versus Private Insurance with Dual Theory: A Political Economy Argument

This paper analyzes the political support for public insurance in the presence of a private insurance alternative. The public insurance is compulsory and offers a uniform insurance policy. The private insurance is voluntary and can offer different insurance policies. Adopting Yaari's [Econometrica, 55, 95–115, 1987] dual theory to expected utility (i.e., risk aversion without diminishing marginal utility of income), we show that adverse selection on the private insurance market may lead a majority of individuals to prefer public insurance over private insurance, even if the median risk is below the average risk (so that the median actually subsidizes high-risk individuals). We also show that risk aversion makes public insurance more attractive and that the dual theory is less favourable to a mixed insurance system than the expected utility framework. Lastly, we demonstrate how the use of genetic tests may threaten the political viability of public insurance.     

The dynamics of government

We model income redistribution with dynamic distortions as determined by rational voting without commitment among individuals of different types and income realizations. We find that redistribution is too persistent relative to that chosen by a planner with commitment. The difference is larger, the lower is the political influence of young agents, the lower is the altruistic concern for future generations, and the lower is risk-aversion. Furthermore, there tends to be too much redistribution in the political equilibrium. Finally, smooth preference aggregation, as under probabilistic voting, produces less persistence and does not admit multiple equilibria, which occur under majority-voting aggregation.     

Democracy, Public Expenditures, and the Poor: Understanding Political Incentives for Providing Public Services

The incentives of politicians to provide broad public goodsand reduce poverty vary across countries. Even in democracies,politicians often have incentives to divert resources to politicalrents and private transfers that benefit a few citizens at theexpense of many. These distortions can be traced to imperfectionsin political markets that are greater in some countries thanin others. This article reviews the theory and evidence on theimpact on political incentives of incomplete information forvoters, the lack of credibility of political promises, and socialpolarization. The analysis has implications for policy and forreforms to improve public goods provision and reduce poverty.      

Financial Distortions and Economic Growth: Empirical Evidence

Conventional wisdom suggests a negative relation between financial distortions and economic growth. This paper incorporates the financial premium, a good proxy for the degree of restrictions on financial transactions, into a standard AK-type endogenous growth model. The analytical results suggest that such a relationship does not exist. Economic growth is insulated by the financial premium, contrasting with previously held beliefs. Agents' patience and the attitude of relative risk aversion are noteworthy in explaining the effects of external distortions on economic growth. Our findings may apply to economies with parallel exchange markets.     

Risk aversion measures: comparing attitudes and asset allocation

Households' reported willingness to take financial risk is compared to the riskiness of their portfolios, measured as risky assets to wealth. Overall, their portfolio allocations are reliable indicators of attitudes toward risk, demonstrating an understanding of their relative level of risk taking. Multivariate regression analysis using multiply imputed data from the 1989 Survey of Consumer Finances indicates that households generally exhibit decreasing relative risk aversion. Further, investment in risky assets is significantly related to socioeconomic factors, attitude toward risk taking, desire to leave an estate and expectations about the adequacy of Social Security and pension income.     

Capital mobility and international sharing of cyclical risk

This paper investigates whether the international globalization of financial markets allows for significant cross-country risk-sharing at the business cycle frequency. We find that cross-country risk-sharing is still limited and this is unlikely to be the result of financial frictions that limit state-contingent contracts. Part of the limited international risk sharing could be the consequence of frictions that de-facto reduce the short-term mobility of financial capital. But even with these frictions we find significant divergence between model predictions and the data.     

Accounting for decarbonisation and reducing capital at risk in the S&P500

This article accounts for carbon emissions in the S&P 500 and explores the extent to which capital is at risk from decarbonising value chains. At a global level it is proving difficult to decouple carbon emissions from GDP growth. Top-down legal and regulatory arrangements envisaged by the Kyoto Protocol are practically redundant given inconsistent political commitment to mitigating global climate change and promoting sustainability. The United Nations Environment Programme (UNEP) and European Commission (EC) are promoting the role of financial markets and financial institutions as drivers of behavioural change mobilising capital allocations to decarbonise corporate activity.     

How important is intra-household risk sharing for savings and labor supply?

While it is recognized that the family is a risk-sharing institution, little is known about the quantitative effects of this source of insurance on savings and labor supply. In this paper, we present a model where workers (females and males) are subject to idiosyncratic employment risk and where capital markets are incomplete. A household is formed by a female and a male, who decide on consumption, savings and labor supplies. In a calibrated version of our model we find that intra-household risk sharing has its largest impact among wealth-poor households. While the wealth-rich use mainly savings to smooth consumption across unemployment spells, wealth-poor households rely on spousal labor supply. For instance, for low-wealth households, average hours worked by wives of unemployed husbands are 8% higher than those worked by wives of employed husbands. This response in wives’ hours makes up 9% of lost family income. We also study consumption losses upon an unemployment spell, precautionary savings and the crowding out effects of the public unemployment insurance program on the extent of risk sharing within the household.     

Risk-sharing function in internal capital markets: Evidence from intragroup reinsurance activities

This study explicitly investigates the risk-sharing function of internal capital markets by analyzing intragroup reinsurance (a substitute for capital) activities in the United States' non-life insurance sector. We find supporting evidence that intragroup reinsurance participants are generally associated with smoother income flows, and such an income smoothing effect exists for both ceding and assuming firms. Further to prior studies, we find that internal reinsurance ceded exerts both direct and indirect effects on premiums growth in the aftermath of the financial crisis in 2007 and 2008. In addition to direct capacity support, the reduction in income volatility is another channel through which intragroup reinsurance enhances ceding firms' premiums growth. In the presence of market turmoil, the risk-sharing function can lower member firms' insolvency risk and thus enable them to pursue business growth.     

Banks Increase Welfare

This paper examines the relative degrees of risk sharing provided by demand deposit contracts and equity contracts. It is shown that in a framework in which individuals have smooth preferences and there exists some type of aggregate uncertainty (interest rate risk), the allocations obtained with a financial intermediary allow in general for greater risk sharing than those achieved in an equity economy. However, the interest rate is essential in order to determine the superiority of demand deposit contracts over equity contracts. The results of the paper contradict the ones obtained by Jacklin [1987] and Hellwig [1994], where demand deposit and equity contracts are always equivalent risk sharing instruments.     

Distance still matters. The hard reality of global expansion

Companies routinely overestimate the attractiveness of foreign markets. Dazzled by the sheer size of untapped markets, they lose sight of the difficulties of pioneering new, often very different territories. The problem is rooted in the analytic tools (the most prominent being country portfolio analysis, or CPA) that managers use to judge international investments. By focusing on national wealth, consumer income, and people's propensity to consume, CPA emphasizes potential sales, ignoring the costs and risks of doing business in a new market. Most of these costs and risks result from the barriers created by distance. "Distance," however, does not refer only to geography; its other dimensions can make foreign markets considerably more or less attractive. The CAGE framework of distance presented here considers four attributes: cultural distance (religious beliefs, race, social norms, and language that are different for the target country and the country of the company considering expansion); administrative or political distance (colony-colonizer links, common currency, and trade arrangements); geographic distance (the physical distance between the two countries, the size of the target country, access to waterways and the ocean, internal topography, and transportation and communications infrastructures); and economic distance (disparities in the two countries' wealth or consumer income and variations in the cost and quality of financial and other resources). This framework can help to identify the ways in which potential markets may be distant from existing ones. The article explores how (and by how much) various types of distance can affect different types of industries and shows how dramatically an explicit consideration of distance can change a company's picture of its strategic options.     

TIME VARIABILITY IN MARKET RISK AVERSION

We adopt realized covariances to estimate the coefficient of risk aversion across portfolios and through time. Our approach yields second moments that are free from measurement error and not influenced by a specified model for expected returns. Supporting the permanent income hypothesis, we find risk aversion responds to consumption-smoothing behavior. As income increases, or as the consumption-to-income ratio falls, relative risk aversion decreases. We also document variation in risk aversion across portfolios: risk aversion is highest for small and value portfolios.     

Does knowledge of finance mitigate the gender difference in financial risk-aversion?

We investigate the gender difference in financial risk aversion using a survey of finance professors from universities across the United States. We compare their actual portfolio allocations to that of respondents in the Federal Reserve's Survey of Consumer Finances (SCF). We find that among highly educated individuals, women are significantly more risk averse than men. However, we find that when men and women have both attained a high level of financial education, they are equally likely to invest a significant portion of their portfolio in risky assets, suggesting that financial education mitigates the gender difference in financial risk aversion.     

Annuity Markets and Retirement Security

The growing importance of defined contribution pension arrangements has drawn increased attention to the means by which retired people draw down their assets. Current UK law requires annuitisation of at least a fraction of defined contribution plan accumulations. Annuity markets have recently attracted some criticism with respect to pricing and the available range of product options. This paper describes a key feature of voluntary annuity markets: the presence of ‘adverse selection’. This is the tendency of annuitants to live longer than non‐annuitants, since individuals who know that they are likely to die soon do not purchase annuities. The paper presents information that quantifies the importance of adverse selection in the setting of private annuity prices and discusses the role of compulsory annuitisation requirements in reducing it. Requiring individuals to participate in the annuity market can reduce selection effects, at the cost of reducing individuals' range of retirement income options.     

Stock market aversion? Political preferences and stock market participation

We find that left-wing voters and politicians are less likely to invest in stocks, controlling for income, wealth, education, and other relevant factors. This finding from unique data sets in Finland is robust both at the zip code and at the individual level. A moderate left voter is 17–20% less likely to own stocks than a moderate right voter. The results are consistent with the idea that personal values are a factor in important investment decisions, in this case leading to “stock market aversion.” The results are inconsistent with alternative explanations such as wealth effects, risk aversion, reverse causality, return expectations, or social capital.     

Wealth effects and committed cost allocation: An agency theory perspective

In this article we examine the effects of committed costs (CC) on compensation and effort (production) decisions in a principal-agent (P-A) setting. In the case where moral hazard is present, the compensation and effort (production) decisions are independent of CC whenever P has constant absolute risk aversion. When P has decreasing absolute risk aversion, he demands as increased risk premium, therefore increases the spread of the compensation schedule, and induces A to increase effort (production) and vice versa. The optimal compensation scheme can be decomposed to conform to incentive schemes that are generally observed in practice. In particular, we decompose the optimal compensation scheme that depends on CC into two parts—a part that is based on cash flows and a part that is based on income (after allocating committed costs). In the case where effort is observable, CC does not effect the compensation scheme and effort decisions, when P has constant absolute risk aversion. In contrast to earlier studies that examine the owner-manager case, when P has decreasing absolute risk aversion, effort (production) could either increase or decrease. The presence of moral hazard affects the effort (production) decision differently than when risk-sharing considerations alone exist. The reduction in A's compensation induced by increased CC never exceeds the amount of CC.     

Sub-nationals' risk premia in fiscal federations: Fiscal performance and institutional design

The recent debt crisis in Europe highlighted the importance of institutional design and, in particular, bail-out clauses in determining States' risk premia in fiscal or quasi-fiscal federations. This paper examines the determinants of sub-national governments' risk premia in fiscal federations using secondary market data for the USA, Canada, Australia and Germany. It finds that, as for central governments, fiscal fundamentals matter in the pricing of risk, and sub-national governments with higher public debt and larger deficits pay higher premia. However, this relationship is not uniform across federations and it differs with institutional arrangements. In particular, market pricing mechanisms are less effective in presence of explicit or implicit guarantees from the central government. We show that when sub-national governments depend on high transfers from the central government (i.e., when there is some form of implicit guarantee from the center), markets are less responsive to sub-national governments' fiscal fundamentals. Using primary market data, the paper also shows that high transfer dependency lowers the probability of sub-national governments to borrow on capital markets.     

Insider Trading, Investment, and Liquidity: A Welfare Analysis

We compare equilibrium trading outcomes with and without participation by an informed insider, assuming inflexible ex ante aggregate investment choices by agents. Noise trading arises from aggregate uncertainty regarding other agents' intertemporal consumption preferences. The welfare levels of outsiders can thus be ascertained. The allocations without insider trading are not ex ante Pareto efficient, because our model differs from standard ones with negative exponential utility functions and normal returns. We characterize the circumstances under which the revelation of payoff-relevant information via prices—arising from insider trading—benefits outsiders with stochastic liquidity needs, by improving risk-sharing among them.     

Extracting Information from Options Markets: Smiles, State–Price Densities and Risk Aversion

In this paper, recent techniques of estimating implied information from derivatives markets are presented and applied empirically to the French derivatives market. We determine nonparametric implied volatility functions, state–price densities and historical densities from a high–frequency CAC 40 stock index option dataset. Moreover, we construct an estimator of the risk aversion function implied by the joint observation of the cross–section of option prices and time–series of underlying asset value. We report a decreasing implied volatility curve with the moneyness of the option. The estimated relative risk aversion functions are positive and globally consistent with the decreasing relative risk aversion assumption.