Discussion Paper No. 132
November 8, 2021
Overconfidence and Bailouts
Author:
Abstract:
Empirical evidence suggests that managerial overconfidence and government guarantees contribute substantially to excessive risk-taking in the banking industry. This paper incorporates managerial overconfidence and limited bank liability into a principal-agent model, where the bank manager unobservably chooses effort and risk. An overconfident manager overestimates the returns to effort and risk. We find that managerial overconfidence necessitates an intervention into banker pay. This is due to the bank's exploitation of the manager's overvaluation of bonuses, which causes excessive risk-taking in equilibrium. Moreover, we show that the optimal bonus tax rises in overconfidence, if risk-shifting incentives are sufficiently large. Finally, the model indicates that overconfident managers are more likely to be found in banks with large government guarantees, low bonus taxes, and lax capital requirements.
Keywords:
overconfidence; bailouts; banking regulation; bonus taxes;
JEL-Classification:
Download:
Discussion Paper No. 99
November 4, 2021
Multinational Banks in Regulated Markets: Financial Integration Desirable?
Author:
Abstract:
We set up a two-country, regional model of trade in financial services. Competitive firms in each country manufacture non-traded consumer goods in an uncertain productive environment, borrowing funds from a bank in either the home or the foreign market. Duopolistic banks can choose their levels of monitoring of firms and thus the levels of risk-taking, where the risk of bank failure is partly borne by taxpayers in the banks' home countries. Moreover, each bank chooses the allocation of its lending between domestic and foreign firms, while the bank's overall loan volume is fixed by a capital requirement set optimally in its home country. In this setting we consider two types of financial integration. A reduction in the compliance costs of cross-border banking reduces aggregate output and increases risk-taking, thus harming consumers and taxpayers in both countries. In contrast, a reduction in the costs of screening foreign firms is likely to be eneficial for banks, consumers, and taxpayers alike.
Keywords:
multinational banks; foreign direct investment; capital regulation; financial integration;
JEL-Classification:
Download:
Discussion Paper No. 90
Monetary Policy Obeying the Taylor Principle Turn Prices Into Strategic Substitutes
Author:
Abstract:
Monetary policy affects the degree of strategic complementarity in firms pricing decisions if it responds to the aggregate price level. In normal times, when monopolistic competitive firms increase their prices, the central bank raises interest rates, which lowers consumption demand and creates an incentive for firms to reduce their prices. Thereby, monetary policy reduces the degree of strategic complementarities among firms pricing decisions and even turns prices into strategic substitutes if the effect of interest rates on demand is sufficiently strong. We show that this condition holds when monetary policy follows the Taylor principle. By contrast, in a liquidity trap where monetary policy is restricted by the zero lower bound, pricing decisions are strategic complements. Our main contribution consists in relating the determinacy and stability of equilibria to strategic substitutability in prices. We discuss the consequences for dynamic adjustment processes and some policy implications.
Keywords:
monopolistic competition; monetary policy rule; pricing decisions; strategic complementarity; strategic substitutability;
JEL-Classification:
Download:
Discussion Paper No. 34
November 3, 2021
Bonus Taxes and International Competition for Bank Managers
Author:
Abstract:
We analyze the competition in bonus taxation when banks compensate their managers by means of fixed and incentive pay and bankers are internationally mobile. Banks choose bonus payments that induce excessive managerial risk-taking to maximize their private benefits of existing government bailout guarantees. In this setting the international competition in bonus taxes may feature a ‘race to the bottom’ or a ‘race to the top’, depending on whether bankers are a source of net positive tax revenue or inflict net fiscal losses on taxpayers as a result of incentive pay. A ‘race to the top’ becomes more likely when governments’ impose only lax capital requirements on banks, whereas a ‘race to the bottom’ is more likely when bank losses are partly collectivized in a banking union.
Keywords:
bonus taxes; international tax competition; migration;
JEL-Classification:
Download:
Discussion Paper No. 11
The Power of Sunspots: an Experimental Analysis
Author:
Abstract:
This paper presents an experiment on a coordination game with extrinsic random signals, in which we systematically vary the stochastic process generating these signals and measure how signals affect be- havior. We find that sunspot equilibria emerge naturally if there are salient public signals. However, highly correlated private signals can also lead to sunspot-driven behavior, even when this is not an equi- librium. Private signals reduce the power of public signals as sunspot variables. The higher the correla- tion of extrinsic signals and the more easily they can be aggregated, the more powerful these signals are in distracting actions from the action that minimizes strategic uncertainty.
Keywords:
coordination games; strategic uncertainty; sunspot equilibria; forward guidance; expectations;
JEL-Classification:
Download:
Discussion Paper No. 7
November 2, 2021
Regulatory Competition in Capital Standards with Selection Effects among Banks
Author:
Abstract:
Several countries have recently introduced national capital standards exceed- ing the internationally coordinated Basel III rules, which is inconsistent with the ‘race to the bottom’ in capital standards found in the literature. We study reg- ulatory competition when banks are heterogeneous and give loans to firms that produce output in an integrated market. In this setting capital requirements change the pool quality of banks in each country and inflict negative external- ities on neighboring jurisdictions by shifting risks to foreign taxpayers and by reducing total credit supply and output. Non-cooperatively set capital standards are higher than coordinated ones and a ‘race to the top’ occurs when governments care equally about bank profits, taxpayers, and consumers.
Keywords:
regulatory competition; capital requirements; bank heterogeneity;
JEL-Classification: