Nominal Stability and Financial Globalization

Over the past four decades, there has been a substantial increase in financial globalization, that is, rapid growth in gross external portfolio positions. There has also been a substantial fall in the variability of inflation. Many economists have conjectured that financial globalization contributed to the improved inflation performance. This paper explores the causal link running in the opposite direction. Using an open economy model with endogenous portfolio choice, it is shown that a monetary rule that reduces inflation variability tends to increase the size of gross external asset positions. This result appears to be robust across different modeling specifications.     

Optimal Nonlinear Income Taxation with Habit Formation

It has recently been shown that incorporating “keeping up with the Joneses” preferences into a prototypical two‐ability‐type optimal nonlinear income tax model leads to higher marginal tax rates for both types of agents. In particular, the high‐skill type faces a positive marginal tax rate, rather than zero as in the conventional case. In this paper, agents’ utility functions are postulated to exhibit “habit formation in consumption” such that the prototypical two‐ability‐type optimal nonlinear income tax model becomes a dynamic analytical framework. We show that if the government can commit to its future fiscal policy, the presence of consumption habits does not affect the standard results on optimal marginal tax rates. By contrast, if the government cannot precommit, the high‐skill type will face a negative marginal tax rate, while the low‐skill type’s marginal tax rate remains positive.     

BESTSELLER LISTS AND PRODUCT VARIETY*

This paper uses detailed weekly data on sales of hardcover fiction books to evaluate the impact of the New York Times bestseller list on sales and product variety. In order to circumvent the obvious problem of simultaneity of sales and bestseller status, the analysis exploits time lags and accidental omissions in the construction of the list. The empirical results indicate that appearing on the list leads to a modest increase in sales for the average book, and that the effect is more dramatic for bestsellers by debut authors. The paper discusses how the additional concentration of demand on top‐selling books could lead to a reduction in the privately optimal number of books to publish. However, the data suggest the opposite is true: the market expansion effect of bestseller lists appears to dominate any business stealing from non‐bestselling titles.     

Strategic Financial Disclosure: Evidence from Labor Negotiations

Abstract. Evidence of strategic behavior in public financial disclosure is provided by analyzing 673 disclosures that were made before, during, and after four Canadian labor strikes. Financial disclosures included quantitative and qualitative information about the sampled companies that appeared in print media during the periods of interest. Strategic behavior involved the naming of one actor by another in the disclosures. The analyses showed that disclosure frequency was much higher during and immediately preceding the strikes than in other periods. Network-analytic techniques were employed to examine the linkages among seven groups of actors that were named in the disclosures. The disclosure networks increased in density during the strikes but became less centralized. Our analysis supports the view that strategic interactions in disclosures are multilateral and dynamic. Thus, any attempt to model financial disclosure during labor negotiations as a bilateral single-period game would appear to be simplistic. Disclosure management in this setting seems to occur within a complex economic and social setting.     

HARD OR SOFT? INSTITUTIONAL REFORMS AND INFRASTRUCTURE SPENDING AS DETERMINANTS OF FOREIGN DIRECT INVESTMENT IN CHINA*

We examine whether hard infrastructure in the form of more highways and railroads or soft infrastructure in the form of more transparent institutions and deeper reforms lead to more foreign direct investment (FDI). We use data on FDI from the United States, Japan, Hong Kong, Taiwanese and Korea to various regions of China from 1990 to 2002. We control for the standard determinants of FDI—regional market sizes, wage rates, human capital and tax policies. Then we add indices of hard and soft infrastructures. We found that empirically soft infrastructure consistently outperforms hard infrastructure as a determinant of FDI.     

The Macroeconomics of Shadow Banking

We build a macrofinance model of shadow banking—the transformation of risky assets into securities that are money‐like in quiet times but become illiquid when uncertainty spikes. Shadow banking economizes on scarce collateral, expanding liquidity provision, boosting asset prices and growth, but also building up fragility. A rise in uncertainty raises shadow banking spreads, forcing financial institutions to switch to collateral‐intensive funding. Shadow banking collapses, liquidity provision shrinks, liquidity premia and discount rates rise, asset prices and investment fall. The model generates slow recoveries, collateral runs, and flight‐to‐quality effects, and it sheds light on Large‐Scale Asset Purchases, Operation Twist, and other interventions.     

Volatility‐Managed Portfolios

Managed portfolios that take less risk when volatility is high produce large alphas, increase Sharpe ratios, and produce large utility gains for mean‐variance investors. We document this for the market, value, momentum, profitability, return on equity, investment, and betting‐against‐beta factors, as well as the currency carry trade. Volatility timing increases Sharpe ratios because changes in volatility are not offset by proportional changes in expected returns. Our strategy is contrary to conventional wisdom because it takes relatively less risk in recessions. This rules out typical risk‐based explanations and is a challenge to structural models of time‐varying expected returns.