nep-fdg New Economics Papers
on Financial Development and Growth
Issue of 2022‒04‒04
twenty-six papers chosen by
Georg Man

  1. Symmetric and Asymmetric Effects of Financial Deepening on Income Inequality in South Africa By Mduduzi Biyase; Carolyn Chisadza
  2. Does the Pattern of Age Dependency Matter in the Promotion of Financial Development in an Emerging Economy? By Mantu Kumar Mahalik; John Nkwoma Inekwe; Kuntal K. Das; Umakant Dash; Augustine C Arize
  3. Forecasting GDP growth using stock returns in Japan: A factor-augmented MIDAS approach By Morita, Hiroshi
  4. Nowcasting real GDP in Tunisia using large datasets and mixed-frequency models By Hagher Ben Rhomdhane; Brahim Mehdi Benlallouna
  5. Dividend Imputation, Investment and Capital Accumulation in Open Economies By Chung Tran; Sebastian Wende
  6. Cross-border regulatory spillovers and macroprudential policy coordination By Pierre-Richard Agénor; Timothy Jackson; Luiz Awazu Pereira da Silva
  7. Out of sight, out of mind? Global chains, export, and credit allocation in bad times By Minetti, Raoul; Murro, Pierluigi; Peruzzi, Valentina
  8. Financial conditions and zombie companies: International evidence By Joel Bowman
  9. The Economics of Nonperforming Loans (Japanese) By KOBAYASHI Keiichiro
  10. Wealth Inequality and the Exploration of Novel Alternatives By Alessandro Spiganti
  11. The Firm Size-Leverage Relationship and Its Implications for Entry and Business Concentration By Satyajit Chatterjee; Burcu Eyigungor
  12. The Effects of Credit Lines on Cash Holdings and Capital Investment: Evidence from Japan By Honda, Tomohito
  13. Lower for longer under endogenous technology growth By Elfsbacka Schmöller, Michaela; Spitzer, Martin
  14. The Return on Private Capital: Rising and Diverging By Robert S. Chirinko; Debdulal Mallick
  15. The effects of sovereign risk: A high frequency identification based on news ticker data By Staffa, Ruben
  16. Greenfield Foreign Direct Investment: Social Learning drives Persistence By Joe Cho Yiu NG; Thomas Chao Hung CHAN; Byron Kwok Ping TSANG; Charles Ka Yui LEUNG
  17. China in Europe: FDI Trends and Policy Responses in the 17+1 Region and Austria By Zuzana Zavarská
  18. Tracing Banks' Credit Allocation to their Funding Costs By Anne Duquerroy; Adrien Matray; Farzad Saidi
  19. Fiscal Stimulus and Commercial Bank Lending Under COVID-19 By Joshua Aizenman; Yothin Jinjarak; Mark M. Spiegel
  20. Market Power and Market Structure: An Analysis of Costa Rican Banking since 2008 By Miguel Cantillo; José Cascante; Guillermo Pastrana
  21. Modeling Bank Panics: Challenges By Lawrence Christiano; Husnu Dalgic; Xiaoming Li
  22. A Crises-Bailouts Game By Bruno Salcedo; Bruno Sultanum; Ruilin Zhou
  23. Yields: The Galapagos Syndrome Of Cryptofinance By Bernhard K. Meister; Henry C. W. Price
  24. The Coming Battle of Digital Currencies By Cong, Lin William; Mayer, Simon
  25. Darwin Among the Cryptocurrencies By Bernhard K. Meister; Henry C. W. Price
  26. The impact of climate transition risks on financial stability. A systemic risk approach By Ojea-Ferreiro, Javier; Reboredo, Juan C.; Ugolini, Andrea

  1. By: Mduduzi Biyase (Economic Development and Well-being Research Group (EDWRG), School of Economics, University of Johannesburg); Carolyn Chisadza (Department of Economics, University of Pretoria, Private Bag X20, Hatfield 0028, South Africa)
    Abstract: The aim of this study is to examine the financial development-inequality nexus in South Africa from 1980 to 2017, specifically if financial deepening reduces income inequality. The asymmetric effects of financial deepening on income inequality is investigated by employing the autoregressive distributed lag by Pesaran et al. (2001). The initial results indicate a positive association between financial deepening and income inequality. On further exploration, we find evidence that the Greenwood and Jovanovich hypothesis holds for South Africa. We observe an inverted non-linear relationship between financial deepening and income inequality in the long-run. The results suggest that at early stages of financial development, income inequality increases, but gradually starts to decrease as the financial sector becomes more established in the long-run. The findings highlight the need for policymakers to focus on inclusive financial sector reforms in the early stages of development.
    Keywords: financial deepening, income inequality, ARDL, South Africa
    JEL: C22 D63 G20 O55
    Date: 2022–02
  2. By: Mantu Kumar Mahalik; John Nkwoma Inekwe; Kuntal K. Das (University of Canterbury); Umakant Dash; Augustine C Arize
    Abstract: In this study, we examine the financial development effect of population aging pattern in India. We examine the period 1960 to 2017 and analyse the various types of age dependency which includes both old and young measures. By using structural VAR and ARDL techniques, we find that changes in young age dependency have a significant impact on changes in financial development in India while dependency by the old generation does not affect it. This study suggests that government and policymakers should protect the health and working conditions of young age people for the promotion of better financial development in India.
    Keywords: Financial Development; Age Dependency; SVAR; India
    JEL: F39 J11 C22
    Date: 2022–03–01
  3. By: Morita, Hiroshi
    Abstract: Asset prices reflect expectations of future economic conditions. In this study, we use the property of asset prices, especially stock prices, to forecast the GDP growth rate in Japan. For optimal use of the rich time-series and cross-sectional information of stock prices, we combine MIDAS (mixed-data sampling) regression and factor analysis to examine which dimensions of information contribute to the accuracy of the GDP growth rate forecast. Our results show that the use of factors significantly improves forecast accuracy and that extracting factors from a broader set of stock prices further improves accuracy. This highlights the important role of cross-sectional stock market information in forecasting macroeconomic activity.
    Keywords: Forecasting, MIDAS regression, factor model, stock returns
    JEL: C22 C53 E37
    Date: 2022–03
  4. By: Hagher Ben Rhomdhane (Central Bank of Tunisia); Brahim Mehdi Benlallouna (Central Bank of Tunisia)
    Abstract: This study aims to construct a new monthly leading indicator for Tunisian economic activity and to forecast Tunisian quarterly real GDP (RGDP) using several mixed-frequency models. These include a mixed dynamic factor model, unrestricted mixed-data sampling (UMIDAS), and a threepass regression filter (3PRF) developed at the Central Bank of Tunisia, based on a monthly/quarterly set of economic and financial indicators as predictors. Our methodology is based on direct and indirect approaches, and the direct approach nowcasts aggregate RGDPs. The indirect approach is a disaggregated approach based on the output side of GDP (manufacturing, non-manufacturing, and services) using a set of available monthly indicators by sector. Furthermore, mixed-frequency dynamic factor models and unrestricted MIDAS perform well in terms of root mean squared errors compared to the benchmark model VAR (2). The forecast errors derived from the disaggregated approach during the recent COVID period are smaller than those derived from classical models such as VAR (2). In our model, we used indicators such as electricity consumption by sector, stock market index detailed by sector, and international economic surveys to capture the pandemic effect. The financial variables improve forecasting for all horizons. Additionally, we find that it is better to employ several UMIDAS-ARs by each component of GDP at constant prices and to pool the results rather than relying on aggregated GDP, specifically in volatile times.
    Keywords: Mixed-Frequency Data Sampling; Nowcasting; short-term forecasting
    JEL: E37 C55 F17 O11
    Date: 2022–03–07
  5. By: Chung Tran; Sebastian Wende
    Abstract: A dividend imputation system is designed to address double taxation of capital income by allowing companies to pass on profit taxes paid at the corporate level to shareholders in form of franking tax credits. In this paper, we study implications of dividend imputation in a small open economy model with firm heterogeneity and an internationally integrated capital market. Our analysis indicates that dividend imputation has opposing effects on investment and capital accumulation. On one hand, it mitigates the adverse effects of double taxation and induces more saving and investment; on other hand, it raises the cost of investment for firms that are not fully imputed, which subsequently results in less investment. Moreover, different tax treatments for resident and foreign investors amplify frictions in reallocation of capital across firms, which prevents inflows of foreign capital from fully offsetting the shortage of domestic savings. International investors are not marginal investors in our small open economy setting. Overall, the net effect on capital accumulation is analytically ambiguous, depending on which force is dominant. Our quantitative results indicate that the positive force is dominant and removing dividend imputation leads to decreases in domestic savings, aggregate capital and output. Interestingly, the overall welfare effect is positive as low income households benefit more from additional government transfers, while tax burdens are shifted towards high income households and foreign investors.
    Keywords: Double taxation; Franking tax credit; Fiscal policy; Firm heterogeneity; Overlapping generations; Open economy; Dynamic general equilibrium; Welfare.
    JEL: D21 E62 H21 H22 H25
    Date: 2022–03
  6. By: Pierre-Richard Agénor; Timothy Jackson; Luiz Awazu Pereira da Silva
    Abstract: A core-periphery model with financial frictions, imperfect financial integration, and cross-border banking is used to assess the magnitude of regulatory spillovers and the gains from international macroprudential policy coordination. A core global bank lends to its affiliates in the periphery and banks in both regions are subject to risk-sensitive capital regulation. Following an expansionary monetary policy in the core, a countercyclical response in capital requirements induces the global bank to engage in regulatory arbitrage. The magnitude of the resulting cross-border capital flows depends on the degree of economies of scope in lending. Welfare gains associated with countercyclical capital buffers are calculated for three policy regimes: independent policies (Nash), coordination, and reciprocity---a regime in which capital ratios set in the core are imposed on branches operating in the periphery. If regulators set policies on the basis of a narrow financial stability mandate, and these policies are evaluated in terms of household welfare, reciprocity may perform better than Nash, and as well as coordination for all parties, when regulatory leakages are strong.
    Keywords: global banking, financial spillovers, regulatory leakages, macroprudential policy coordination.
    JEL: E58 F42 F62
    Date: 2022–03
  7. By: Minetti, Raoul (Michigan State University, Department of Economics); Murro, Pierluigi (LUISS University); Peruzzi, Valentina (Sapienza University of Rome)
    Abstract: We investigate whether globally active firms are more likely to be credit constrained by banks during a financial crisis. Using data on 15,000 businesses from seven European countries, we find that firms with a stable involvement in global value chains were 25% less likely to be rationed by banks during the 2009 financial crisis. This contrasts with the stronger likelihood of credit rationing of firms engaging in plain vanilla export activities. Matching the firm-level information with bank-level data, we obtain that banks insulated global chain participants from the credit crunch, not only accounting for the beneficial effects of global supply chain participation, but also to minimize negative spillovers on their own activities abroad.
    Keywords: Banks; global value chains; firm export; financial crises
    JEL: D22 F10 G20
    Date: 2022–02–28
  8. By: Joel Bowman
    Abstract: Financial conditions eased after the global financial crisis and during the COVID-19 pandemic as policymakers across most countries adopted large scale monetary policy easing. This has increased concern amongst some that a prolonged period of accommodative financial conditions has fostered the growth of zombie companies − businesses that are consistently unable to meet their interest expenses from current profits. This paper finds that an easing in self-constructed measures of financial conditions is correlated with an increase in the share of resources sunk into zombie companies using a sample of listed companies across 20 OECD countries and 11 industries over the period 2003 to 2019. However, the size of this relationship is higher for countries with banking systems that are in poorer financial health. As a result, fears that accommodative financial conditions foster more capital being sunk into inefficient zombie companies is likely to be less of a concern for countries with healthy banking systems.
    Keywords: Financial Conditions, Zombie Companies, Bank Health
    JEL: E44 E52 G21
    Date: 2022–03
  9. By: KOBAYASHI Keiichiro
    Abstract: This paper reviews the history of Japan's experience on the prolonged disposal of the nonperforming loans and summarizes a new theory of debt overhang. The disposal of the nonperforming loans was delayed because of the existence of the persistent expectations that any day, land price and stock prices will both rise, and the perception that the nonperforming loans are not the cause of the recession, but the result of it. Compartmentalized thinking and moral inconsistency or paternalism in the mindset of the policymakers is also a factor. The nonperforming loans cause the inefficiency of debt overhang. In the existing research, debt overhang is modeled as inefficiency due to the lack of borrower's commitment. In the new theory, we focus on the lack of lender's commitment, which discourages the borrowers and stagnates the economy. Debt reduction due to the disposal of nonperforming loans reduces the inefficiency of the lack of lender commitment and increase the payoffs of both the lender and borrower.
    Date: 2022–03
  10. By: Alessandro Spiganti (Department of Economics, University Of Venice CÃ Foscari)
    Abstract: I investigate whether wealth inequality hinders the discovery of novel alternatives in a competitive screening model. Agents can engage in experimentation, which may lead to the discovery of superior technologies, while wasting time with inferior ones. Talented agents are better at weeding out inferior actions, but talent is unobservable by lenders. When agents are poor, this causes an adverse selection problem and experimentation is also pursued by untalented agents. As economies become wealthier, this misallocation problem weakens. Higher inequality worsens the misallocation problem when the economy is rich, but can increase efficiency in poor economies.
    Keywords: inequality of opportunity, bandit problem; unobservable talent, competitive screening
    JEL: D53 D82 O31
    Date: 2022
  11. By: Satyajit Chatterjee; Burcu Eyigungor
    Abstract: Larger firms (by sales or employment) have higher leverage. This pattern is explained using a model in which firms produce multiple varieties, acquire new varieties from their inventors, and borrow against the future cash flow of the firm with the option to default. A variety can die with a constant probability, implying that firms with more varieties (bigger firms) have a lower variance of sales growth and, in equilibrium, higher leverage. In this setup, a drop in the risk-free rate increases the value of an acquisition more for bigger firms because of their higher leverage: They can (and do) borrow a larger fraction of their future cash flow. The drop causes existing firms to buy more of the new varieties arriving into the economy, resulting in a lower startup rate and greater concentration of sales.
    Keywords: Startup rates; concentration; leverage; firm dynamics
    JEL: E22 E43 E44 G32 G33 G34
    Date: 2022–03–17
  12. By: Honda, Tomohito
    Abstract: This study examines how credit lines affect corporate cash holdings and capital investment, using hand-collected data on credit lines for publicly traded Japanese firms for 2006–2017. Although theoretical research has explained the effects of credit lines in terms of the extensive margin, previous empirical studies have investigated the impacts of credit lines focusing on the intensive margin. Against this background, the present study concentrates on the extensive margin of the effects of credit lines and compares firms that have access to credit lines with those that do not. The empirical results are as follows: (1) firms with credit lines hold lower cash reserves than those without; (2) firms with credit lines undertake more capital investment than firms without; and (3) once firms gain access to credit lines, their cash holdings decrease and their capital investment increases. These empirical findings are consistent with the predictions of the theoretical literature and suggest that credit lines improve firms’ financial flexibility and enable firms to use cash holdings held for precautionary reasons for investment instead.
    Keywords: Credit lines, Cash holdings, Corporate investment, Financial constraints
    JEL: G31 G32
    Date: 2022–03
  13. By: Elfsbacka Schmöller, Michaela; Spitzer, Martin
    Abstract: This paper studies monetary policy strategies under endogenous technology dynamics and low r∗. Endogenous growth strengthens the gains from make-up strategies relative to inflation targeting, especially if policy space is reduced. This result is due to the long-run non-neutrality of money and the hysteresis effects in TFP through which ELB episodes generate permanent scars on long-run aggregate supply. Make-up strategies not only foster the alignment of inflation with target but also support productivity-improving investment in R&D and technology adoption and hence the long-run trend path, provided that the inherent make-up element is sufficiently pronounced. Inflation is less responsive to monetary policy due to the interaction with productivity dynamics. As a result, additional stimulus is required at the ELB and the degree of subsequent overshooting is alleviated. Endogenous growth also generates novel monetary policy trade-offs, most notably credibility challenges, which can be mitigated by confining make-up elements to ELB episodes.
    JEL: E24 E31 E32 E52 O30
    Date: 2022–03–31
  14. By: Robert S. Chirinko (Professor, Department of Finance, University of Illinois at Chicago (E-mail:; Debdulal Mallick (Associate Professor, Department of Economics, Deakin University (E-mail:
    Abstract: We study the return on private capital across 88 countries for 1970-2014. The return on private capital has exhibited two phases, approximately constant from 1970-1990, but then rising dramatically from 1991-2014. This latter increase occurs for both Rich/Developed and Poor/ Developing countries, though at an uneven pace; the Lucas Paradox seems to have become more pronounced in recent years. Despite falling real interest rates lowering the returns on private capital, 60% of the secular rise in the returns in poor countries is explained by rising equity risk, depreciation, and markups and by the capital loss from expected decreases in the relative price of new capital. These same factors explain 163% of the secular rise in the returns of private capital in rich countries (i.e., the factors rise more than the returns). Policy implications are discussed.
    Keywords: Return on private capital, International capital allocations
    JEL: E22 F21 O10
    Date: 2022–03
  15. By: Staffa, Ruben
    Abstract: This paper uses novel news ticker data to evaluate the effect of sovereign risk on economic and financial outcomes. The use of intraday news enables me to derive policy events and respective timestamps that potentially alter investors' beliefs about a sovereign's willingness to service its debt and thereby sovereign risk. Following the high frequency identification literature, in the tradition of Kuttner (2001) and Guerkaynak et al. (2005), associated variation in sovereign risk is then obtained by capturing bond price movements within narrowly defined time windows around the event time. I conduct the outlined identification for Italy since its large bond market and its frequent coverage in the news render it a suitable candidate country. Using the identified shocks in an instrumental variable local projection setting yields a strong instrument and robust results in line with theoretical predictions. I document a dampening effect of sovereign risk on output. Also, borrowing costs for the private sector increase and inflation rises in response to higher sovereign risk.
    Keywords: high frequency identification,instrument,local projections,sovereign risk,text data
    JEL: C36 E43 E62
    Date: 2022
  16. By: Joe Cho Yiu NG; Thomas Chao Hung CHAN; Byron Kwok Ping TSANG; Charles Ka Yui LEUNG
    Abstract: This paper argues that the persistence of greenfield foreign direct investment (FDI) comes from information frictions. First, our simple social learning model shows that, through signaling effects, information frictions generate persistent greenfield FDI inflows. Second, we show empirically that the autoregressive coefficient of greenfield FDI increases in value with different proxies for information frictions, including six institutional and governance indicators and two common language measures. We also find that greenfield FDI persistence varies across industries. In particular, greenfield FDI by service firms is more persistent than that by manufacturing firms. Finally, our findings suggest that better governance, predictability, and transparency reduce information frictions and thereby avoiding drastic and persistent ups and downs in FDI.
    Date: 2022–03
  17. By: Zuzana Zavarská (The Vienna Institute for International Economic Studies, wiiw)
    Abstract: Finding common ground across EU member states in responding to China’s increasingly prominent position in the global economy has thus far proven a challenge. As the EU tries to find a ‘third way’ for dealing with its most important trading partners amid heightened US-China tensions, selected countries within the CESEE region have been deepening their investment relations with China. Given these countries’ significant capital needs for economic development, and in view of the EU’s arguable neglect of parts of the region, it is hardly surprising that they would be incentivised to seek out alternative investors. In addition to managing the risks arising from debt dependencies, China’s growing position in the 17+1 countries’ energy sectors may present a possible risk area. The EU investment screening mechanism is unlikely to align strategic interests across member states in its present scope, given the deficiencies in enforcement. With Austria’s established investment presence and relative geographical proximity to the 17+1 countries, it needs to play a key role in moving the dialogue in the direction of harmonising EU investment screening mechanisms, aligning incentives through greater involvement of the Western Balkans in development financing from the EU and offering realistic EU accession prospects. The Comprehensive Agreement on Investment (CAI) would have constituted a positive step towards a mutually beneficial and competitively neutral investment relationship with China, despite its numerous shortcomings. Austria and the EU-CEE countries should therefore lean towards resumed engagement with China regarding the possible ratification of the CAI, keeping core European values in mind. The EU should prioritise proactive policies to drive growth at home, leveraging the continent’s innovation capacities, and not only rely on defensive mechanisms to keep out unwanted FDI. Ultimately, Austria should recognise and emphasise mutual respect and co-operation towards common goals among the world’s major trading blocs, despite sometimes profound differences in economic models.
    Keywords: EU, China, foreign direct investment, investment screening, investment agreements
    JEL: F13 F21 F42
    Date: 2022–03
  18. By: Anne Duquerroy (Banque de France); Adrien Matray (Princeton & CEPR); Farzad Saidi (University of Bonn & CEPR)
    Abstract: We quantify how banks’ funding costs affect their lending behavior directly, and in-directly by feeding back to their net worth. For identification, we exploit banks’ het-erogeneous liability structure and the existence of regulated deposits in France whose rates are set by the government. Using administrative credit-registry and regulatory bank data, we find that a one-percentage-point increase in funding costs reduces credit by 17%. To insulate their profits, banks reach for yield and rebalance their lending towards smaller and riskier firms. These changes are not compensated for by less af-fected banks at the aggregate city level, with repercussions for firms’ investment.
    Keywords: bank funding costs, monetary-policy transmission, deposits, credit supply, SMEs, savings
    JEL: E23 E32 E44 G20 G21 L14
    Date: 2022–02
  19. By: Joshua Aizenman; Yothin Jinjarak; Mark M. Spiegel
    Abstract: We investigate the implications of extra-normal government spending under the COVID-19 pandemic for commercial bank lending growth between 2019Q4 and 2020Q4 in a large sample of over 3000 banks from 71 countries. We control for pre-pandemic structural factors, bank characteristics and government debt. To address the likely endogeneity of government assistance under the pandemic, we instrument for extra-normal spending using disparities in pre-existing national political characteristics for identification. Our results indicate that while higher government spending was associated with higher commercial bank lending, higher public debt going into the crisis weakened the expansionary effects of higher spending on bank lending at economically and statistically significant levels. Moreover, this sensitivity is higher among weaker banks, suggesting that bank lending responses to government spending under COVID-19 reflected the perceived implications of such spending for government assistance of the banking sector going forward. Our results are robust to a variety of sensitivity analyses, including perturbations in specification, sample, and estimation methodology.
    Keywords: fiscal multiplier; COVID-19; bank lending
    JEL: E62 F34 G21 H30
    Date: 2022–02–23
  20. By: Miguel Cantillo (Universidad de Costa Rica); José Cascante (Carlos III University); Guillermo Pastrana (Toulouse School of Economics)
    Abstract: This paper analyzes the evolution of the Lerner index for Costa Rican banks between 2008 and 2019. We document a significant drop in market power during this period, which we relate to less concentration in loans and deposits. The market became less consolidated as a fringe of 29 small banks gained market share at the expense of large and medium banks. We find that for individual banks, a greater market share of loans, and greater loan specialization are related to higher profitability, while a greater market share of deposits and greater size are related to lower profit margins.
    Keywords: Banking structure, Latin American banking sector, Market power, Imperfect competition, Lerner index, Umbrella pricing.
    Date: 2022–03
  21. By: Lawrence Christiano; Husnu Dalgic; Xiaoming Li
    Abstract: Our primary finding is that surprisingly small changes in assumptions which determine the amount of net worth available in a bank panic have an important impact on the nature of the equilibria: there may not be a bank panic at all, or there may be several di erent panics of di erent severity. The economic reasons for this sensitivity are clarified by transforming the market economy into a game and studying banker best response functions. To establish robustness to model details, we report similar quantitative results across three di erent model specifications and calibrations. A second, additional result, is displayed in a three-period version of the panic model of Gertler and Kiyotaki (2015). That model naturally suggests the idea that welfare can be improved by imposing a restriction on bank leverage. We compute the Ramsey-optimal leverage restriction, but find that there is an implementation problem: the restriction can be associated with more than one equilibrium, not just the desired one. We discuss one way to address the implementation problem.
    Keywords: Bank runs, financial crises, macroprudential policy
    JEL: E44 G01 G21
    Date: 2022–03
  22. By: Bruno Salcedo; Bruno Sultanum; Ruilin Zhou
    Abstract: This paper studies the optimal design of a liability-sharing arrangement as an infinitely repeated game. We construct a noncooperative model with two agents: one active and one passive. The active agent can take a costly and unobservable action to reduce the incidence of crisis, but a crisis is costly for both agents. When a crisis occurs, each agent decides unilaterally how much to contribute mitigating it. For the one-shot game, when the avoidance cost is too high relative to the expected loss of crisis for the active agent, the first-best is not achievable. That is, the active agent cannot be induced to put in effort to minimize the incidence of crisis in a static game. We show that with the same stage-game environment, the first-best cannot be implemented as a perfect public equilibrium (PPE) of the infinitely repeated game either. Instead, at any constrained efficient PPE, the active agent "shirks" infinitely often, and when crisis happens, the active agent is "bailed out" infinitely often. The frequencies of crisis and bailout are endogenously determined in equilibrium. The welfare optimal equilibrium being characterized by recurrent crises and bailouts is consistent with historical episodes of financial crises, which features varying frequency and varied external responses for troubled institutions and countries in the real world. We explore some comparative statics of the PPEs of the repeated game numerically.
    Keywords: Bailouts; Moral Hazard; Repeated Games; Imperfect monitoring; Second best
    JEL: C73 D82
    Date: 2022–01–05
  23. By: Bernhard K. Meister; Henry C. W. Price
    Abstract: In this chapter structures that generate yield in cryptofinance will be analyzed and related to leverage. While the majority of crypto-assets do not have intrinsic yields in and of themselves, similar to cash holdings of fiat currency, revolutionary innovation based on smart contracts, which enable decentralised finance, does generate return. Examples include lending or providing liquidity to an automated market maker on a decentralised exchange, as well as performing block formation in a proof of stake blockchain. On centralised exchanges, perpetual and finite duration futures can trade at a premium or discount to the spot market for extended periods with one side of the transaction earning a yield. Disparities in yield exist between products and venues as a result of market segmentation and risk profile differences. Cryptofinance was initially shunned by legacy finance and developed independently. This led to curious and imaginative adaptions, reminiscent of Darwin's finches, including stable coins for dollar transfers, perpetuals for leverage, and a new class of exchanges for trading and investment.
    Date: 2022–02
  24. By: Cong, Lin William; Mayer, Simon
    Abstract: We model the dynamic global competition among national fat currencies, cryptocurrencies, and Central Bank Digital Currencies (CBDCs) in which the strength of a country and of its currency are mutually reinforcing. The rise of cryptocurrencies hurts stronger fat currencies, but can beneft weaker fat currencies by reducing competition from stronger ones. Countries strategically implement CBDCs in response to competition from emerging cryptocurrencies and other currencies. Our model suggests the following pecking order: Countries with strong but non-dominant currencies (e.g., China) are most incentivized to launch CBDC due to both technological frst-mover advantage and potential reduction in dollarization; the strongest currencies (e.g., USD) beneft from developing CBDC early on to nip cryptocurrency growth in the bud and to counteract competitors’ CBDCs; nations with the weakest currencies forgo implementing CBDCs and adopt cryptocurrencies instead. Strong fat competition and the emergence of cryptocurrencies spur fnancial innovation and digital currency development. Our fndings help rationalize recent developments in currency and payment digitization, while providing insights into the global battle of currencies and the future of money.
    Keywords: Financial Economics
    Date: 2022–03–28
  25. By: Bernhard K. Meister; Henry C. W. Price
    Abstract: The paper highlights some commonalities between the development of cryptocurrencies and the evolution of ecosystems. Concepts from evolutionary finance embedded in toy models consistent with stylized facts are employed to understand what survival of the fittest means in cryptofinance. Stylized facts for ownership, trading volume and market capitalization of cryptocurrencies are selectively presented in terms of scaling laws.
    Date: 2022–02
  26. By: Ojea-Ferreiro, Javier (European Commission); Reboredo, Juan C. (Universidade de Santiago de Compostela); Ugolini, Andrea (University of Milan-Bicocca)
    Abstract: Transitioning to a low-carbon economy involves risks for the value of financial assets, with potential ramifications for financial stability. We quantify the systemic impact on financial firms arising from changes in the value of financial assets under three climate transition scenarios that reflect different levels of vulnerability to the transition to a low-carbon economy, namely, orderly transition, disorderly transition, and no transition (hot house world). We describe three systemic risk metrics computed from a copula-based model of dependence between financial firm returns and financial asset market returns: climate transition expected returns, climate transition value-at-risk, and climate transition expected shortfall. Empirical evidence for European financial firms over the period 2013-2020 indicates that the climate transition risk varies across sectors and countries, with banks and real estate firms experiencing the highest and lowest systemic impacts from a disorderly transition, respectively. We find that default premium, yield slope and inflation are the main drivers of climate transition risk, and that, in terms of capital shortfall, the cost of rescuing more risk-exposed financial firms from climate transition losses is relatively manageable. Simulation of climate risks over a five-year period shows that disorderly transition can be expected to imply significant costs for banks, while financial services and real estate firms remain more sheltered.
    Keywords: Climate risks, financial stability, systemic risk, copulas
    JEL: C32 C58 G01 G20 G28
    Date: 2022–01

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