Bank Mergers,REIT Loan Pricing and Takeover Likelihood

The impact of bank mergers on Real Estate Investment Trust (REIT) loan pricing and takeover likelihood is assessed. REITs that lose their primary banking relationship due to bank mergers pay higher interest rates on future borrowings. Bank consolidation reduces bank competition for REIT loans which affects loan pricing. Moreover, based on randomly matched samples of REITs, the results imply that firms losing their agent banks due to bank mergers and those with limited access to bank debt are more likely to be acquired while REITs associated with acquiring banks are more likely to acquire other firms. Additional analysis of the 92 merged REITs reveals that 33% of the target REITs’ banks are merged with their REIT acquirers’ banks prior to the REIT mergers while 67% of the target REITs share at least one major bank with their acquirer.     

The Impact of Surplus Distribution on the Risk Exposure of With Profit Life Insurance Policies Including Interest Rate Guarantees

This article analyzes the numerical impact of different surplus distribution mechanisms on the risk exposure of a life insurance company selling with profit life insurance policies with a cliquet‐style interest rate guarantee. Three representative companies are considered, each using a different type of surplus distribution: a mechanism, where the guaranteed interest rate also applies to surplus that has been credited in the past, a slightly less restrictive type in which a guaranteed rate of interest of 0 percent applies to past surplus, and a third mechanism that allows for the company to use former surplus in order to compensate for underperformance in “bad” years. Although at the outset all contracts offer the same guaranteed benefit at maturity, a distribution mechanism of the third type yields preferable results with respect to the considered risk measure. In particular, throughout the analysis, our representative company 3 faces ceteris paribus a significantly lower shortfall risk than the other two companies. Offering “strong” guarantees puts companies at a significant competitive disadvantage relative to insurers providing only the third type of surplus distribution mechanism.     

Formal targets, central bank independence and inflation dynamics in the UK: A Markov-Switching approach

We examine inflation and uncertainty in the UK with a version of the Markov Switching model, which allows for changes in the variance as well as in the mean and persistence of a series. We find that the UK’s attempts at exchange rate pegs in the form of shadowing the deutschmark and entering the ERM were ineffective, and in the latter case counterproductive in lowering inflation uncertainty. The 1981 budget, however, greatly lowered uncertainty, and the adoption of a formal inflation target also had a palpable, negative impact on inflation uncertainty. As a suggestive exercise, we examine inflation uncertainty in the US, and find that, over 2005–2008, in the absence of an inflation target, uncertainty rose in the US, while uncertainty remained low in the UK over this period of rising commodity prices and financial turmoil.     

WHAT YOU DON'T KNOW CAN HURT YOU: KNOWLEDGE PROBLEMS IN MONETARY POLICY

Many economists hold that monetary policy missteps played a role in causing or prolonging the 2007–2008 financial crisis. In light of the perceived failure of monetary orthodoxy, models are being theoretically refined and empirically recalibrated. Absent from these technical debates is a recognition of the immense knowledge burdens inherent in monetary policy. We argue that Fed authorities do not have the knowledge required to achieve their own monetary objectives, given their inability to approximately measure or predict changes in the demand for money. Finally, we evaluate the ability of free banking to overcome this knowledge problem. (JEL E42, E52, E58, E61, P16)     

Supply and marginal firms in general equilibrium

For economies with a large number of small firms, price induced changes in supply are decomposed into substitution and entry effects. Marginal firms (those earning zero profit) play a significant role in the determination of the slope of aggregate supply.     

Stochastic imitative game dynamics with committed agents

We consider models of stochastic evolution in two-strategy games in which agents employ imitative decision rules. We introduce committed agents: for each strategy, we suppose that there is at least one agent who plays that strategy without fail. We show that unlike the standard imitative model, the model with committed agents generates unambiguous infinite horizon predictions: the asymptotics of the stationary distribution do not depend on the order in which the mutation rate and population size are taken to their limits.     

Correlates of Narrow Bracketing

Behavior often deviates from standard predictions because individuals evaluate the consequences of choices separately (i.e., narrow bracketing) rather than jointly. The main existing theories classify different narrow bracketing phenomena as either (i) choice errors caused by cognitive limitations, or (ii) strategies to achieve self‐control. Using an online experiment, we find consistent evidence for theory (ii): mental budgets and narrow goals are related to each other and to measures of self‐control, but are distinct from other forms of narrow bracketing. Evidence for the complementary theory (i) is less consistent: few choice bracketing phenomena are related to each other and to cognitive skills.     

Half empty, half full and why we can agree to disagree forever

Aumann [Aumann R., 1976. Agreeing to disagree. Annals of Statisitics 4, 1236–1239] derives his famous we cannot agree to disagree result under the assumption that people are expected utility (=EU) decision makers. Motivated by empirical evidence against EU theory, we study the possibility of agreeing to disagree within the framework of Choquet expected utility (=CEU) theory which generalizes EU theory by allowing for ambiguous beliefs. As our first main contribution, we show that people may well agree to disagree if their Bayesian updating of ambiguous beliefs is psychologically biased in our sense. Remarkably, this finding holds regardless of whether people with identical priors apply the same psychologically biased Bayesian update rule or not. As our second main contribution, we develop a formal model of Bayesian learning under ambiguity. As a key feature of our approach the posterior subjective beliefs do, in general, not converge to “true” probabilities which is in line with psychological evidence against converging learning behavior. This finding thus formally establishes that CEU decision makers may even agree to disagree in the long-run despite the fact that they always received the same information.     

Past experience of uncertainty affects risk aversion

In an experiment with more than 500 participants we study how past experience of uncertainty (imperfect knowledge of the state space) affects risk preferences. Participants in our experiment choose between a sure outcome and a lottery in 32 periods. All treatments are exactly identical in periods 17–32 but differ in periods 1–16. In the early periods of the risk treatment there is perfect information about the lottery; in the ambiguity Treatment participants perfectly know the outcome space but not the associated probabilities; in the unawareness treatment participants have imperfect knowledge about both outcomes and probabilities. We observe strong treatment effects on behavior in periods 17–32. In particular, participants who have been exposed to an environment with very imperfect knowledge of the state space subsequently choose lotteries with high (low) variance less (more) often compared to other participants. Estimating individual risk attitudes from choices in periods 17–32 we find that the distribution of risk attitude parameters across our treatments can be ranked in terms of first order stochastic dominance. Our results show how exposure to environments with different degrees of uncertainty can affect individuals’ subsequent risk-taking behavior.