Showing papers by "CEMFI published in 2005"

Youth Emancipation and Perceived Job Insecurity of Parents and Children

Abstract: The age at which children leave the parental home differs considerably across countries. In this paper we argue that lower job insecurity of parents and higher job insecurity of children delay emancipation. We provide aggregate evidence which supports this hypothesis for 12 European countries and which helps account for the increase in coresidence in the 1990s. We also give microeconometric evidence for Italy, a country for which we have access to household-specific information on job security of fathers and coresidence. In the late 1990s, approximately 75% of young Italians aged 18 to 35 were living at home and they had only a 4% probability of emancipation in the 3 subsequent years. We show that this probability would have increased by 4 to 10 percentage points if their fathers had gone from perceiving to have a fully secure job to expecting to be unemployed for sure.

Estimation and Testing of Dynamic Models with Generalized Hyperbolic Innovations

Abstract: We analyze the Generalized Hyperbolic distribution adequacy to model kurtosis and asymmetries in multivariate conditionally heteroskedastic dynamic regression models. We standardize this distribution, obtain analytical expressions for the log-likelihood score, and explain how to evaluate the information matrix. We also derive tests for the null hypotheses of multivariate normal and Student t innovations, and decompose them into skewness and kurtosis components, from which we obtain more powerful one-sided versions. Finally, we present an empirical application to five NASDAQ sectorial stock returns that indicates that their conditional distribution is asymmetric and leptokurtic, which can be successfully exploited for risk management purposes.

Financial Markets and Wages

Abstract: We study a labour market equilibrium model in which firms sign optimal long-term contracts with workers. Firms that are financially constrained offer an increasing wage profile: they pay lower wages today in exchange of higher wages once they become unconstrained and operate at a larger scale. In equilibrium, constrained firms are on average smaller and pay lower wages. In this way the model generates a positive relation between firm size and wages. Using data from the National Longitudinal Survey of Youth (NLSY) we show that the key dynamic properties of the model are supported by the data.

Borrowing from employees: wage dynamics with financial constraints

Abstract: We analyze how the financial conditions of the firm affect the compensation structure of workers, the size of the firm, and its dynamics. Firms that are financially constrained offer long-term wage contracts characterized by an increasing wage profile, that is, they pay lower wages today in exchange of higher future wages, effectively borrowing form their employees. Because constrained firms also operate at a suboptimal scale, which then increases gradually over time, we have that younger and smaller firms grow faster and pay lower wages.

Precautionary Savings or Working Longer Hours

Abstract: This paper quantifies the macroeconomic implications of the lack of insurance against idiosyncratic labour market risk. I show that in a model economy calibrated to observed individual level data, households make ample use of work effort as a consumption smoothing mechanism. As a consequence, aggregate consumption is 0.6% lower, work effort is 18% higher and labour productivity is 12% lower than they would be in a complete markets setting. Not surprisingly, the welfare benefits of moving towards complete markets are very large. Accounting for the whole transition to the new complete markets steady state I find the welfare costs of market incompleteness above 16% of individual lifetime consumption.

Do we need to worry about credit risk correlation

Abstract: Yes we do. This article shows that any firm9s credit risk is, to a very large extent, driven by common risk factors affecting all firms. Using a reduced form model and sequential Kalman filtering estimation, we decompose the credit risk of a sample of corporate bonds (14 U.S. firms, 2001–2003) into different unobservable risk factors. A single common factor accounts for more than 50% of all (but two) of the firms9 credit risk levels, with an average of 68% across firms. This factor represents the credit risk levels underlying the U.S. economy and is strongly correlated with main U.S. stock indexes.

Job Insecurity and Youth Emancipation: A Theoretical Approach

Abstract: In this paper, we propose a theoretical model to study the effect of income insecurity of parents and offspring on the child's residential choice. Parents are partially altruistic toward their children and will provide financial help to an independent child when her income is low relative to the parents'. We show that first-order stochastic dominance (FOSD) shifts in the distribution of the child's future income (or her parents') will have ambiguous effects on the child's residential choice. The analysis identifies altruism as the source of ambiguity in the results. If parents are selfish or the joint income distribution of parents and child places no mass on the region where transfers are provided, a FOSD shift in the distribution of the child's (parents') future income will reduce (raise) the child's current income threshold for independence.

Financing and the Protection of Innovators

Abstract: The protection that innovators obtain through intellectual property rights crucially depends on their incentives and ability to litigate infringers. Taking patents as a notable example, we study how the financing of legal costs can alter the incentives to litigate in defense of a patent and, thus, the prospects of infringement and the effective protection of the innovator. We compare the resort to a financier once the infringement has occurred (ex-post financing) with patent litigation insurance (PLI) as well as other ex-ante arrangements based on leverage. We show that the ex-ante arrangements can be designed (for instance, in the case of PLI, by including an appropriate deductible) so as to implement the innovator's second-best outcome: a situation in which patent predation is deterred without inducing excessive litigation.

Least Squares Predictions and Mean-Variance Analysis

Abstract: We compare the Sharpe ratios of traders who combine one riskless and one risky asset following (i) buy and hold strategies; (ii) timing strategies with forecasts from simple; or (iii) multiple regressions; and (iv) passive allocations of (i) and (ii) with mean-variance optimizers. We show that (iv) implicitly uses the linear forecasting rule that maximizes the Sharpe ratio of managed portfolios, but the remaining rankings are unclear. We also suggest generalized method of moments (GMM) estimators to make (iv) operational and evaluate their significance with spanning tests. Finally, we characterize the equivalence between (iii) and (iv), and propose moment tests to assess it.

Least Squares Predictions and Mean-Variance Analysis

Abstract: We compare the Sharpe ratios of traders who combine one riskless and one risky asset following (i) buy and hold strategies; (ii) timing strategies with forecasts from simple; or (iii) multiple regressions; and (iv) passive allocations of (i) and (ii) with mean-variance optimizers. We show that (iv) implicitly uses the linear forecasting rule that maximizes the Sharpe ratio of managed portfolios, but the remaining rankings are unclear. We also suggest generalized method of moments (GMM) estimators to make (iv) operational and evaluate their significance with spanning tests. Finally, we characterize the equivalence between (iii) and (iv), and propose moment tests to assess it. Copyright 2005, Oxford University Press.

Regulation and Opportunism: How Much Activism Do We Need?

Abstract: This paper analyzes the current trend towards firms' self-regulation as opposed to the formal regulation of a negative externality. Firms respond to increasing activism in the market(conscious consumers that take into account the external effects of their purchase) by providing more socially responsible goods. However, because regulation is the outcome of a political process, an increase in activism might imply an inefficiently higher externality level. This may happen when a majority of non-activist consumers collectively free-ride on conscious consumers. By determining a softer than optimal regulation, they benefit from the behavior of firms, yet they have access to cheaper (although less efficient) goods.

Liquidity, Risk-Taking and the Lender of Last Resort

Abstract: This paper studies the strategic interaction between a bank whose deposits are randomly withdrawn, and a lender of last resort (LLR) that bases its decision on supervisory information on the quality of the bank's assets. The bank is subject to a capital requirement and chooses the liquidity buffer that it wants to hold and the risk of its loan portfolio. The equilibrium choice of risk is shown to be decreasing in the capital requirement, and increasing in the interest rate charged by the LLR. Moreover, when the LLR does not charge penalty rates, the bank chooses the same level of risk and a smaller liquidity buffer than in the absence of a LLR. Thus, in contrast with the general view, the existence of a LLR does not increase the incentives to take risk, while penalty rates do.

Youth Emancipation and Perceived Job Insecurity of Parents and Children

Abstract: The age at which children leave the parental home differs considerably across countries. In this paper we argue that lower job insecurity of parents and higher job insecurity of children delay emancipation. We provide aggregate evidence which supports this hypothesis for 12 European countries and which helps account for the increase in coresidence in the 1990s. We also give microeconometric evidence for Italy, a country for which we have access to household-specific information on job security of fathers and coresidence. In the late 1990s, approximately 75% of young Italians aged 18 to 35 were living at home and they had only a 4% probability of emancipation in the 3 subsequent years. We show that this probability would have increased by 4 to 10 percentage points if their fathers had gone from perceiving to have a fully secure job to expecting to be unemployed for sure.

Financial Markets and Wages

Abstract: We study a labor market equilibrium model in which firms sign optimal long-term contracts with workers. Firms that are financially constrained offer an increasing wage profile: They pay lower wages today in exchange of higher wages once they become unconstrained and operate at a larger scale. In equilibrium, constrained firms are on average smaller and pay lower wages. In this way the model generates a positive relation between firm size and wages. Using data from the National Longitudinal Survey of Youth (NLSY) we show that the key dynamic properties of the model are supported by the data.

Precautionary Savings or Working Longer Hours

Abstract: This paper quantifies the macroeconomic implications of the lack of insurance against idiosyncratic labour market risk. I show that in a model economy calibrated to observed individual level data, households make ample use of work effort as a consumption smoothing mechanism. As a consequence, aggregate consumption is 0.6% lower, work effort is 18% higher and labour productivity is 12% lower than they would be in a complete markets setting. Not surprisingly, the welfare benefits of moving towards complete markets are very large. Accounting for the whole transition to the new complete markets steady state I find the welfare costs of market incompleteness above 16% of individual lifetime consumption.

The Pervasive Absence of Compensating Differentials

Abstract: We write and estimate a dynamic model of wages, amenities and labor mobility.Workers trade off wage and amenity offers when deciding whether to change jobs,while facing heterogenous mobility costs. We show that these frictions can turn strongindividual preferences for non wage characteristics into very small wage/amenity cor-relation in cross section. We use voluntary job-to-job transitions to identify workers'Marginal Willingness to Pay for amenities. The resulting selection model is solvedusing alternative types of constrained transitions in order to proxy the distribution ofjob offers. We take the model to a panel of nine European countries while control-ling for unobserved heterogeneity. Our estimates show large MWP, more than 20% ofthe wage, for amenities such as the type of work or job security. We also find strongevidence of heterogeneity in mobility costs, and consequently weak wage/amenity incross-section.

A Genetic Algorithm for the Structural Estimation of Games with Multiple Equilibria

Abstract: This paper proposes an algorithm to obtain maximum likelihood estimates of structural parameters in discrete games with multiple equilibria. The method combines a genetic algorithm (GA) with a pseudo maximum likelihood (PML) procedure. The GA searches efficiently over the huge space of possible combinations of equilibria in the data. The PML procedure avoids the repeated computation of equilibria for each trial value of the parameters of interest. To test the ability of this method to get maximum likelihood estimates, we present a Monte Carlo experiment in the context of a game of price competition and collusion.

R&D in the Pharmaceutical Industry: A World of Small Innovations

Abstract: It is commonly argued that in recent years pharmaceutical companies have directed their R&D towards small improvements of existing compounds instead of more risky drastic innovations. In this paper we show that the proliferation of these small innovations is likely to be linked to the lack of market sensitivity of a part of the demand to changes in prices. Compared to their social contribution, small innovations are relatively more profitable than large ones because they are targeted to the smaller but more inelastic part of the demand. We also study the effect of regulatory instruments such as price ceilings, copayments and reference prices and extend the analysis to competition in research.

A hybrid genetic algorithm for the maximum likelihood estimation of models with multiple equilibria: a first report

Abstract: This paper presents a hybrid genetic algorithm to obtain maximum likelihood estimates of parameters in structural econometric models with multiple equilibria. The algorithm combines a pseudo maximum likelihood (PML) procedure with a genetic algorithm (GA). The GA searches globally over the large space of possible combinations of multiple equilibria in the data. The PML procedure avoids the computation of all the equilibria associated with every trial value of the structural parameters.

The law and finance of venture capital financing in Europe: findings from the RICAFE research project

Abstract: This survey article summarizes the findings of four research projects on the venture capital industry in Europe and the role played by legal institutions and the legal framework. A study on patent litigation insurance argues that insurance can create a level playing field for small innovators, but that compulsory insurance can only be justified as a transitory scheme. The second study argues that intermediaries from countries with a better legal tradition will provide more governance and value added services, even when investing abroad. It also provides supportive empirical evidence based on an extensive questionnaire-study. The third project investigates the relationship between venture investments and a widely used legality index in 39 countries, finding that better laws facilitate faster deal screening and origination, lead to a higher probability of syndication, and also facilitate board representation of the investors. The final study documents a significant performance gap between the European and the US venture capital industry, but argues that the difference can not be attributed to differences in legal origin.

Do We Need to Worry About Credit Risk Correlation

Abstract: Yes we do. This paper shows that any firm's credit risk is, to a very large extent, driven by common risk factors affecting all firms. Using a reduced form model and sequential Kalman filtering estimation we decompose the credit risk of a sample of corporate bonds (14 US firms, 2001-2003) into different unobservable risk factors. A single common factor accounts for more than 50% of all (but two) of the firms' credit risk levels, with an average of 68% across firms. Such factor represents the credit risk levels underlying the US economy and is strongly correlated with main US stock indexes.