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Thursday, August 21, 2014

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Working Papers 2014: Abstracts

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14-23: The Impact of the Home Valuation Code of Conduct on Appraisal and Mortgage Outcomes by Lei Ding and Leonard Nakamura

During the housing crisis, it came to be recognized that inflated home mortgage appraisals were widespread during the subprime boom. The New York State Attorney General’s office investigated this issue with respect to one particular lender and Fannie Mae and Freddie Mac. The investigation resulted in an agreement between the Attorney General’s office, the government-sponsored enterprises (GSEs), and the Federal Housing Finance Agency (the GSEs’ federal regulator) in 2008, in which the GSEs agreed to adopt the Home Valuation Code of Conduct (HVCC). Using unique data sets that contain both approved and nonapproved mortgage applications, this study provides an empirical examination of the impact of the HVCC on appraisal and mortgage outcomes. The results suggest that the HVCC has reduced the probability of inflated valuations and induced a significant increase in low appraisals. The HVCC also made it more difficult to obtain mortgages in the aftermath of the financial crisis.
PDF (636 KB, 34 pages)

14-22: Fiscal Policy: Ex Ante and Ex Post by Dean Croushore and Simon van Norden

The surge in fiscal deficits since 2008 has put a renewed focus on the authors’ understanding of fiscal policy. The interaction of fiscal and monetary policy during this period has also been the subject of much discussion and analysis. This paper gives new insight into past fiscal policy and its influence on monetary policy by examining the U.S. Federal Reserve Board staff’s Greenbook forecasts of fiscal policy. The authors create a real-time database of the Greenbook forecasts of fiscal policy, examine the forecast performance in terms of bias and effciency, and explore the implications for the interaction of fiscal policy and monetary policy. The authors also attempt to provide advice for fiscal policy by showing how policymakers learn over time about the trajectory of the U.S. federal government’s fiscal balance as well as the changing roles of structural and cyclical factors.
PDF (2.71 MB, 53 pages)

14-21: Should Defaults Be Forgotten? Evidence from Variation in Removal of Negative Consumer Credit Information by Marieke Bos and Leonard Nakamura

Practically all industrialized economies restrict the length of time that credit bureaus can retain borrowers’ negative credit information. There is, however, a large variation in the permitted retention times across countries. By exploiting a quasi-experimental variation in this retention time, the authors investigate what happens when negative information is deleted earlier from credit files. The authors find that the loss of information led banks to tighten their lending standards significantly as the expected retention time was diminished from on average three-and-a-half to three years exactly. Simultaneously, they find that borrowers who experience this shorter retention time default more frequently. Since borrowers nevertheless obtain more net access to credit and total defaults do not increase overall, the authors cannot rule out that this reduction in retention time is optimal.
PDF (1.3 MB, 52 pages)

14-20: Macro Fiscal Policy in Economic Unions: States as Agents by Gerald Carlino and Robert P. Inman

An important component of the American Recovery and Reinvestment Act’s (ARRA’s) $796 billion proposed stimulus budget was $318 billion in fiscal assistance to state and local governments, yet the authors have no precise estimates of the impact of such assistance on the macroeconomy. In evaluating ARRA, both the Council of Economic Advisors (CEA) and the Congressional Budget Office (CBO) used instead the impacts of direct federal spending and tax relief. These estimates miss the role of states as agents. The authors provide estimates of aid’s multiplier effects allowing explicitly for state behavior, first from an SVAR analysis separating federal aid from federal tax relief, second from a narrative analysis using the political record for unanticipated federal aid programs, and third from constructed macroeconomic estimates implied by an estimated model of state governments’ fiscal choices. The authors reach three conclusions. First, federal transfers to state and local governments are less stimulative than transfers to households and firms. Second, federal aid for welfare spending is more stimulative than is general purpose aid. Third, an estimated model of state government fiscal behavior provides a microeconomic foundation for the observed macroeconomic impacts of aid.
PDF (1.4 MB, 46 pages)

14-19: Partisan Conflict by Marina Azzimonti

American politics have become extremely polarized in recent decades. This deep political divide has caused significant government dysfunction. Political divisions make the timing, size, and composition of government policy less predictable. According to existing theories, an increase in the degree of economic policy uncertainty or in the volatility of fiscal shocks results in a decline in economic activity. This occurs because businesses and households may be induced to delay decisions that involve high reversibility costs. In addition, disagreement between policymakers may result in stalemate, or, in extreme cases, a government shutdown. This adversely affects the optimal implementation of policy reforms and may result in excessive debt accumulation or inefficient public-sector responses to adverse shocks. Testing these theories has been challenging given the low frequency at which existing measures of partisan conflict have been computed. In this paper, the author provides a novel high-frequency indicator of the degree of partisan conflict. The index, constructed for the period 1891 to 2013, uses a search-based approach that measures the frequency of newspaper articles that report lawmakers’ disagreement about policy. The author shows that the long-run trend of partisan conflict behaves similarly to political polarization and income inequality, especially since the Great Depression. Its short-run fluctuations are highly related to elections, but unrelated to recessions. The lower-than-average values observed during wars suggest a “rally around the flag” effect. The author uses the index to study the effect of an increase in partisan conflict, equivalent to the one observed since the Great Recession, on business cycles. Using a simple VAR, the author finds that an innovation to partisan conflict increases government deficits and significantly discourages investment, output, and employment. Moreover, these declines are persistent, which may help explain the slow recovery observed since the 2007 recession ended.
PDF (10.4 MB, 39 pages)

14-18: Financial Benefits, Travel Costs, and Bankruptcy by Vyacheslav Mikhed and Barry Scholnick

The authors are the first to show that the cost of personal bankruptcy filers traveling to their bankruptcy trustees affects bankruptcy choices. The authors use detailed balance sheet, income statement, and location data from 400,000 Canadian bankruptcies. To control for endogenous trustee selection, the authors use the location of local government offices as an instrument for the location of bankruptcy trustees (while filers interact with trustees, and trustees interact with local government, filers do not interact with the local government). The authors find that increased travel costs reduce the number of filings. Furthermore, for those individuals who do file, the authors find that their increased travel costs need to be compensated by increased financial benefits of bankruptcy. Filers without cars (higher travel costs), as well as those with jobs (higher opportunity costs), receive larger per-kilometer financial benefits from bankruptcy.
PDF (736 KB, 48 pages)

14-17: How Do Exogenous Shocks Cause Bankruptcy? Balance Sheet and Income Statement Channels by Vyacheslav Mikhed and Barry Scholnick

The authors are the first to examine whether exogenous shocks cause personal bankruptcy through the balance sheet channel and/or the income statement channel. For identification, they examine the effect of exogenous, politically motivated government payments on 200,000 Canadian bankruptcy filings. The authors find support for the balance sheet channel, in that receipt of the exogenous cash increases the net balance sheet benefits of bankruptcy (unsecured debt discharged minus liquidated assets forgone) required by filers. The authors also find limited support for the income statement channel, in that exogenous payments reduce bankruptcy filings from individuals whose current expenses exceed their current income.
PDF (582 KB, 42 pages)

14-16: The Evolution of U.S. Community Banks and Its Impact on Small Business Lending by Julapa Jagtiani, Ian Kotliar, and Ramain Quinn Maingi

There have been increasing concerns about the declining number of community banks and that the acquisitions of community banks by larger banks might result in significant reductions in small business lending (SBL) and disrupt relationship lending. This paper examines the roles and characteristics of U.S. community banks in the past decade, covering the recent economic boom and downturn. The authors analyze risk characteristics (including the confidential ratings assigned by bank regulators) of acquired community banks, compare pre- and post-acquisition performance and stock market reactions to these acquisitions, and investigate how the acquisitions have affected small business lending. The authors find that community banks that were merged during the financial crisis period were mostly in poor financial condition and had been rated as unsatisfactory by their regulators on all risk aspects. They also find that the ratio of SBL lending to assets has declined (from 2001 to 2012) for all bank size groups, including community banks. The overall amount of SBL lending tends to increase when the acquirer is a large bank. The authors’ results indicate that mergers involving community bank targets so far have enhanced the overall safety and soundness of the overall banking system and that community bank targets are willing to accept a smaller merger premium (or even a discount) to become a part of a large banking organization. Overall, the decline in the number of community banks during this period does not appear to have adversely impacted SBL lending, and larger bank acquirers have tended to step in and play a larger role in SBL lending.
PDF (1.08 MB, 37 pages)

14-15: Meeting Technologies and Optimal Trading Mechanisms in Competitive Search Markets by Benjamin Lester, Ludo Visschers, and Ronald Wolthoff

In a market in which sellers compete by posting mechanisms, the authors allow for a general meeting technology and show that its properties crucially affect the mechanism that sellers select in equilibrium. In general, it is optimal for sellers to post an auction without a reserve price but with a fee, paid by all buyers who meet with the seller. However, the authors define a novel condition on meeting technologies, which they call invariance, and show that meeting fees are equal to zero if and only if this condition is satisfied. Finally, the authors discuss how invariance is related to other properties of meeting technologies identified in the literature.
PDF (459 KB, 21 pages)

14-14: Trade Adjustment Dynamics and the Welfare Gains from Trade by George Alessandria, Horag Choi, and Kim Ruhl

The authors build a micro-founded two-country dynamic general equilibrium model in which trade responds more to a cut in tariffs in the long run than in the short run. The model introduces a time element to the fixed-variable cost trade-off in a heterogeneous producer trade model. Thus, the dynamics of aggregate trade adjustment arise from producer-level decisions to invest in lowering their future variable export costs. The model is calibrated to match salient features of new exporter growth and provides a new estimate of the exporting technology. At the micro level, the authors find that new exporters commonly incur substantial losses in the first three years in the export market and that export profits are backloaded. At the macro level, the slow export expansion at the producer level leads to sluggishness in the aggregate response of exports to a change in tariffs, with a long-run trade elasticity that is 2.9 times the short-run trade elasticity. The authors estimate the welfare gains from trade from a cut in tariffs, taking into account the transition period. While the intensity of trade expands slowly, consumption overshoots its new steady-state level, so the welfare gains are almost 15 times larger than the long-run change in consumption. Models without this dynamic export decision underestimate the gains to lowering tariffs, particularly when constrained to also match the gradual expansion of aggregate trade flows.
PDF (848 KB, 48 pages)

14-13: Capital Requirements in a Quantitative Model of Banking Industry Dynamics by Dean Corbae and Pablo N. D'Erasmo

The authors develop a model of banking industry dynamics to study the quantitative impact of capital requirements on bank risk taking, commercial bank failure, and market structure. They propose a market structure where big, dominant banks interact with small, competitive fringe banks. Banks accumulate securities like Treasury bills and undertake short-term borrowing when there are cash flow shortfalls. A nontrivial size distribution of banks arises out of endogenous entry and exit, as well as banks’ buffer stocks of securities. The authors test the model using business cycle properties and the bank lending channel across banks of different sizes studied by Kashyap and Stein (2000). They find that a rise in capital requirements from 4% to 6% leads to a substantial reduction in exit rates of small banks and a more concentrated industry. Aggregate loan supply falls and interest rates rise by 50 basis points. The lower exit rate causes the tax/output rate necessary to fund deposit insurance to drop in half. Higher interest rates, however, induce higher loan delinquencies as well as a lower level of intermediated output.
PDF (644 KB, 58 pages)

14-12: Market Exposure and Endogenous Firm Volatility over the Business Cycle by Ryan Decker, Pablo N. D'Erasmo, and Hernan J. Moscoso Boedo

The authors propose a theory of endogenous firm-level volatility over the business cycle based on endogenous market exposure. Firms that reach a larger number of markets diversify market-specific demand risk at a cost. The model is driven only by total factor productivity shocks and captures the business cycle properties of firm-level volatility. Using a panel of U.S. firms (Compustat), the authors empirically document the countercyclical nature of firm-level volatility. They then match this panel to Compustat's Segment data and the U.S. Census's Longitudinal Business Database (LBD) to show that, consistent with their model, measures of market reach are procyclical, and the countercyclicality of firm-level volatility is driven mostly by those firms that adjust the number of markets to which they are exposed. This finding is explained by the negative elasticity between various measures of market exposure and firm-level idiosyncratic volatility the authors uncover using Compustat, the LBD, and the Kauffman Firm Survey.
PDF (634 KB, 58 pages)

14-11: Misallocation, Informality, and Human Capital: Understanding the Role of Institutions by Pablo N. D'Erasmo, Hernan J. Moscoso Boedo, and Asli Senkal

The aim of this paper is to quantify the role of formal-sector institutions in shaping the demand for human capital and the level of informality. The authors propose a firm dynamics model where firms face capital market imperfections and costs of operating in the formal sector. Formal firms have a larger set of production opportunities and the ability to employ skilled workers, but informal firms can avoid the costs of formalization. These firm-level distortions give rise to endogenous formal and informal sectors and, more importantly, affect the demand for skilled workers. The model predicts that countries with a low degree of debt enforcement and high costs of formalization are characterized by relatively lower stocks of skilled workers, larger informal sectors, low allocative efficiency, and measured TFP. Moreover, the authors find that the interaction between entry costs and financial frictions (as opposed to the sum of their individual effects) is the main driver of these differences. This complementarity effect derives from the introduction of skilled workers, which prevents firms from substituting labor for capital and in turn moves them closer to the financial constraint.
PDF (735 KB, 52 pages)

14-10: Forecasting Credit Card Portfolio Losses in the Great Recession: A Study in Model Risk by José J. Canals-Cerdá and Sougata Kerr

Credit card portfolios represent a significant component of the balance sheets of the largest US banks. The charge-off rate in this asset class increased drastically during the Great Recession. The recent economic downturn offers a unique opportunity to analyze the performance of credit risk models applied to credit card portfolios under conditions of economic stress. Specifically, the authors evaluate three potential sources of model risk: model specification, sample selection, and stress scenario selection. Their analysis indicates that model specifications that incorporate interactions between policy variables and core account characteristics generate the most accurate loss projections across risk segments. Models estimated over a time frame that includes a significant economic downturn are able to project levels of credit loss consistent with those experienced during the Great Recession. Models estimated over a time frame that does not include a significant economic downturn can severely under-predict credit loss in some cases, and the level of forecast error can be significantly impacted by model specification assumptions. Higher credit-score segments of the portfolio are proportionally more severely impacted by downturn economic conditions and model specification assumptions. The selection of the stress scenario can have a dramatic impact on projected loss.
PDF (768 KB, 38 pages)

14-9: Competing for Order Flow in OTC Markets by Benjamin Lester, Guillaume Rocheteau, and Pierre-Olivier Weill

The authors develop a model of a two-sided asset market in which trades are intermediated by dealers and are bilateral. Dealers compete to attract order flow by posting the terms at which they execute trades, which can include prices, quantities, and execution times, and investors direct their orders toward dealers that offer the most attractive terms of trade. Equilibrium outcomes have the following properties. First, investors face a trade-off between trading costs and speeds of execution. Second, the asset market is endogenously segmented in the sense that investors with different asset valuations and different asset holdings will trade at different speeds and different costs. For example, under a Leontief technology to match investors and dealers, per unit trading costs decrease with the size of the trade, in accordance with the evidence from the market for corporate bonds. Third, dealers' implicit bargaining powers are endogenous and typically vary across sub-markets. Finally, the authors obtain a rich set of comparative statics both analytically, by studying a limiting economy where trading frictions are small, and numerically. For instance, the authors find that the relationship between trading costs and dealers' bargaining power can be hump-shaped.
PDF (1 MB, 50 pages)

14-8: Foreclosure Delay and Consumer Credit Performance by Paul Calem, Julapa Jagtiani, and William W. Lang

The deep housing market recession from 2008 through 2010 was characterized by a steep increase in the number of foreclosures. Foreclosure timelines — the length of time between initial mortgage delinquency and completion of foreclosure — also expanded significantly, averaging up to three years in some states. Most individuals undergoing foreclosure are experiencing serious financial stress. However, extended foreclosure timelines enable mortgage defaulters to live in their homes without making housing payments until the completion of the foreclosure process, thus providing a liquidity benefit. This paper tests whether the resulting liquidity was used to help cure nonmortgage credit delinquency. The authors find a significant relationship between longer foreclosure timelines and household performance on nonmortgage consumer credit during and after the foreclosure process. Their results indicate that a longer period of nonpayment of housing-related expenses results in higher cure rates on delinquent nonmortgage debts and improved household balance sheets. Foreclosure delay may have mitigated the impact of the economic downturn on credit card default. However, credit card performance may deteriorate in the future as the current foreclosure backlog is cleared and the affected households once again incur housing expenses.
PDF (553 KB, 32 pages)

14-7: The Economics of Debt Collection: Enforcement of Consumer Credit Contracts by Viktar Fedaseyeu and Robert Hunt

In the U.S., third-party debt collection agencies employ more than 140,000 people and recover more than $50 billion each year, mostly from consumers. Informational, legal, and other factors suggest that original creditors should have an advantage in collecting debts owed to them. Then, why does the debt collection industry exist and why is it so large? Explanations based on economies of scale or specialization cannot address many of the observed stylized facts. The authors develop an application of common agency theory that better explains those facts. The model explains how reliance on an unconcentrated industry of third-party debt collection agencies can implement an equilibrium with more intense collections activity than creditors would implement by themselves. The authors derive empirical implications for the nature of the debt collection market and the structure of the debt collection industry. A welfare analysis shows that, under certain conditions, an equilibrium in which creditors rely on third-party debt collectors can generate more credit supply and aggregate borrower surplus than an equilibrium where lenders collect debts owed to them on their own. There are, however, situations where the opposite is true. The model also suggests a number of policy instruments that may improve the functioning of the collections market.
PDF (591 KB, 46 pages)

14-6: Continuous Markov Equilibria with Quasi-Geometric Discounting by Satyajit Chatterjee and Burcu Eyigungor

The authors prove that the standard quasi-geometric discounting model used in dynamic consumer theory and political economics does not possess continuous Markov perfect equilibria (MPE) if there is a strictly positive lower bound on wealth. The authors also show that, at points of discontinuity, the decision maker strictly prefers lotteries over the next period's assets. The authors then extend the standard model to have lotteries and establish the existence of an MPE with continuous decision rules. The models with and without lotteries are numerically compared, and it is shown that the model with lotteries behaves more in accord with economic intuition.
PDF (637 KB, 53 pages)

14-5: The Continuing Power of the Yield Spread in Forecasting Recessions by Dean Croushore and Katherine Marsten

The authors replicate the main results of Rudebusch and Williams (2009), who show that the use of the yield spread in a probit model can predict recessions better than the Survey of Professional Forecasters. Croushore and Marsten investigate the robustness of their results in several ways: extending the sample to include the 2007-09 recession, changing the starting date of the sample, changing the ending date of the sample, using rolling windows of data instead of just an expanding sample, and using alternative measures of the "actual" value of real output. The results show that the Rudebusch-Williams findings are robust in all dimensions.
PDF (1.9 MB, 23 pages)

14-4: Shrinkage Estimation of High-Dimensional Factor Models with Structural Instabilities by Xu Cheng, Zhipeng Liao, and Frank Schorfheide

In high-dimensional factor models, both the factor loadings and the number of factors may change over time. This paper proposes a shrinkage estimator that detects and disentangles these instabilities. The new method simultaneously and consistently estimates the number of pre- and post-break factors, which liberates researchers from sequential testing and achieves uniform control of the family-wise model selection errors over an increasing number of variables. The shrinkage estimator only requires the calculation of principal components and the solution of a convex optimization problem, which makes its computation efficient and accurate. The finite sample performance of the new method is investigated in Monte Carlo simulations. In an empirical application, the authors study the change in factor loadings and emergence of new factors during the Great Recession.
PDF (815 KB, 85 pages)

14-3:Recall and Unemployment by Shigeru Fujita and Giuseppe Moscarini

Using data from the Survey of Income and Program Participation (SIPP) covering 1990-2011, the authors document that a surprisingly large number of workers return to their previous employer after a jobless spell and experience more favorable labor market outcomes than job switchers. Over 40% of all workers separating into unemployment regain employment at their previous employer; over a fifth of them are permanently separated workers who did not have any expectation of recall, unlike those on temporary layoff. Recalls are associated with much shorter unemployment duration and better wage changes. Negative duration dependence of unemployment nearly disappears once recalls are excluded. The authors also find that the probability of finding a new job is more procyclical and volatile than the probability of a recall. Incorporating this fact into an empirical matching function significantly alters its estimated elasticity and the time-series behavior of matching efficiency, especially during the Great Recession. The authors develop a canonical search-and-matching model with a recall option where new matches are mediated by a matching function, while recalls are free and triggered by both aggregate and job-specific shocks. The recall option is lost when the unemployed worker accepts a new job. A quantitative version of the model captures well the authors' cross-sectional and cyclical facts through selection of recalled matches.
PDF (683 KB, 56 pages)

14-2/R: The Perils of Nominal Targets by Roc Armenter

A monetary authority can be committed to pursuing an inflation, price-level, or nominal output target yet systematically fail to achieve the specified goal. Constrained by the zero lower bound on the policy rate, the monetary authority is unable to implement its objectives when private-sector expectations stray from the target in the first place. Low-inflation expectations become self-fulfilling, resulting in an additional Markov equilibrium in which both nominal and real variables are typically below target. Introducing a stabilization goal for long-term nominal rates anchors private-sector expectations on a unique Markov equilibrium without fully compromising the policy responses to shocks.
PDF Icon (551 KB, 37 pages)

14-1: A Tale of Two Commitments: Equilibrium Default and Temptation by Makoto Nakajima

The author constructs the life-cycle model with equilibrium default and preferences featuring temptation and self-control. The model provides quantitatively similar answers to positive questions such as the causes of the observed rise in debt and bankruptcies and macroeconomic implications of the 2005 bankruptcy reform, as the standard model without temptation. However, the temptation model provides contrasting welfare implications, because of overborrowing when the borrowing constraint is relaxed. Specifically, the 2005 bankruptcy reform has an overall negative welfare effect, according to the temptation model, while the effect is positive in the no-temptation model. As for the optimal default punishment, welfare of the agents without temptation is maximized when defaulting results in severe punishment, which provides a strong commitment to repaying and thus a lower default premium. On the other hand, welfare of agents with temptation is maximized when weak punishment leads to a tight borrowing constraint, which provides a commitment against overborrowing.
PDF Icon (612 KB, 40 pages)