Research

Working Papers

-- New! --

Presented at: University of Hamburg, Deutsche Bundesbank, Goethe University Frankfurt

Abstract: Firms with high carbon emissions post more jobs related to disruptive green technologies than comparable low-emission peers. A set of channels shapes this pattern in the supply of technologies. While institutional ownership increases green technology supply particularly by brown firms, public climate awareness makes an impact mainly through green firms. Exposure to climate policies like emissions trading promotes green technology job postings only minimally, but reduces firms' overall technology supply. A portion of these effects comes through firms being financially distressed, which is generally more salient for brown firms than for green firms. Overall, our results suggest that brown firms are actively shifting towards greener business models, but do so in various ways. They respond to investor pressure mainly by expanding their green technology supply, while tighter climate policy and higher financial distress rather incentivize them to reduce their other operations.


-- Under review --

Presented at: Deutsche Bundesbank, BI Oslo, Sveriges Riksbank, ESCB, DGF 2023, Conference on Climate and Energy Finance in Hannover 2023, Green Finance Research Advances 2023 (scheduled)

Abstract: Merging a sample of matched green-conventional bond pairs with data on their ownership structure, we document that the greenium (the yield differential between green and conventional bonds) is largely borne by banks, investment funds, pension funds, insurances and their clients. Strikingly, while investment funds and pension funds pay the greenium largely due to their clients' general green preference, banks display no such pattern. Rather, banks overweight certain bonds that display a sizeable greenium, pointing towards an interaction between the greenium and bank-specific financial frictions. Overall, our findings shed light on the question who finances the green transition and who ultimately pays the costs arising from greening investment portfolios.


-- Under review --

Bundesbank Discussion Paper No. 06/2023

Presented at: Goethe University Frankfurt, Deutsche Bundesbank

Abstract: This article studies long-horizon dynamic asset allocation strategies with recursive parameter updating. The parameter estimates for the regime-switching dynamics vary as more and more datapoints are observed and the sample size increases. In such a setting, the globally optimal portfolio strategy cannot be determined due to computational complexity. Among a set of suboptimal strategies, the portfolio performance can be improved substantially if the dynamics of the regimes are estimated from fundamental macroeconomic data instead of financial return data. Especially after highly uncertain times like the burst of the dotcom bubble or the 2008 financial crisis, the estimation based on financial market data identifies extreme regimes, leading to very extreme hedging demands against regime changes.


-- Significantly revised new version (2023) --

Bundesbank Discussion Paper No. 04/2023

Presented at: University of Hamburg, KWC/SNEE Conference on Sustainable Finance (Lund), GRASFI Conference 2022 (Zurich), EMCC-VI Conference 2022 (Toulouse), ISEFI 2022 (Paris), Euroframe Conference 2021 (online), University of Zurich, Goethe University Frankfurt, ESCB, Deutsche Bundesbank

Abstract: We propose and implement a method to identify shocks to transition risk, addressing key challenges regarding its definition and measurement. Our shocks are instances where significant new information about the economic relevance of climate change increases the valuation of green firms over brown firms. To illustrate our method, we identify shocks to transition risk in the United States. These shocks have important aggregate effects, also inducing financial instability. They are associated with events that increase the likelihood of an orderly transition, and they specifically affect parts of the economy related to fossil fuels and energy. We show that these main results carry over to Germany and the United Kingdom. Still, we find an important role for country specificities.


SAFE Working Paper No. 129, Bank of Lithuania Working Paper No. 36/2016

Presented at: 11th Dynare Conference (Brussels), SGF 2016 (Zurich), 5th Annual Lithuanian Conference on Economic Research (Vilnius), 2016 World Finance Conference (New York), DGF 2016 (Bonn), University of Venice, 9th Biennial Conference of the Czech Economic Society (Prague), University of Bologna, Portsmouth Business School, University College of Dublin, 24th International Conference Computing in Economics and Finance (Milan)

Abstract: We document, both theoretically and empirically, that long-run investment productivity shocks help explain the joint behavior of macroeconomic quantities and asset prices. A two-sector general equilibrium model with long-run investment shocks and wage rigidities produces both positive co-movement among key macroeconomic variables and a sizable spread in expected returns and return volatilities between the investment and consumption sector. Moreover, long-run investment shocks command a positive risk premium. We filter long-run components from US sectoral TFP time series and find empirical evidence in favor of the key model mechanisms in both macroeconomic and asset pricing data.


SAFE Working Paper No. 34

Presented at: SGF 2014 (Zurich), DGF 2014 (Karlsruhe), DGVFM 2014 (Berlin), Wharton School, Goethe University Frankfurt

Abstract: We analyze the equilibrium in a two-tree (sector) economy with two regimes. The output of each tree is driven by a jump-diffusion process, and a downward jump in one sector of the economy can (but need not) trigger a shift to a regime where the likelihood of future jumps is generally higher. Furthermore, the true regime is unobservable, so that the representative Epstein-Zin investor has to extract the probability of being in a certain regime from the data. These two channels help us to match the stylized facts of countercyclical and excessive return volatilities and correlations between sectors. Moreover, the model reproduces the predictability of stock returns in the data without generating consumption growth predictability. The uncertainty about the state also reduces the slope of the term structure of equity. We document that heterogeneity between the two sectors with respect to shock propagation risk can lead to highly persistent aggregate price-dividend ratios. Finally, the possibility of jumps in one sector triggering higher overall jump probabilities boosts jump risk premia while uncertainty about the regime is the reason for sizeable diffusive risk premia.

These working papers represent the authors' personal opinions and do not necessarily reflect the views of the Deutsche Bundesbank or the Eurosystem.

All working papers can be downloaded from SSRN.

Articles in Refereed Journals

Bundesbank Discussion Paper No. 62/2020

There is an online appendix to this paper, containing lots of additional material. The Matlab code for the paper is available on Julian's webpage. A previous version of the paper was entitled "Elephants and the Cross-Section of Expected Returns".

Presented at: Midwest Finance Association 2020, Econometric Society European Winter Meeting 2019 (Rotterdam), DGF 2019 (Essen), SGF 2018 (Zurich), Frontiers of Factor Investing 2018 (Lancaster), KIT, Goethe University Frankfurt, Deutsche Bundesbank

Abstract: When estimating misspecified linear factor models for the cross-section of expected returns using GMM, the explanatory power of these models can be spuriously high when the estimated factor means are allowed to deviate substantially from the sample averages. In fact, by shifting the weights on the moment conditions, any level of cross-sectional fit can be attained. The mathematically correct global minimum of the GMM objective function can be obtained at a parameter vector that is far from the true parameters of the data-generating process. This property is not restricted to small samples, but rather holds in population. It is a feature of the GMM estimation design and applies to both strong and weak factors, as well as to all types of test assets.


Bundesbank Discussion Paper No. 12/2022

featured in: SUERF Policy Brief No.368, 2022

Presented at: EABCN conference on New Challenges to Monetary Policy (Mannheim), Norges Bank, ESCB, Deutsche Bundesbank, Durham-Bristol Banking Policy Forum

Abstract: Using survey data from German households, we find that individuals with higher concern about the consequences of climate change have lower inflation expectations up to five years ahead. We show that the link between climate concern and inflation expectations goes above and beyond individuals' perception of their personal exposures to climate-related risks, their distrust in the central bank, and a broad range of socio-demographic and socio-economic control variables. 


Bundesbank Discussion Paper No. 16/2019

Presented at: WFA 2018 (Coronado), SGF 2018 (Zurich), German Economists Abroad 2017 (Frankfurt), Paris December Finance Meeting 2017, DGF 2017 (Ulm), ESSFM 2017 (Gerzensee), MFA 2017 (Chicago), AFFI 2017 (Valence), 2017 Colloquium on Financial Markets (Cologne), Goethe University, Deutsche Bundesbank, Wharton, BI Oslo, IWH Halle, Swiss National Bank

Abstract: In a parsimonious regime switching model, expected consumption growth varies over time. Adding inflation as a conditioning variable, we uncover two states in which expected consumption growth is low, one with high and one with negative expected inflation. Embedded in a general equilibrium asset pricing model with learning, these dynamics replicate the observed time variation in stock return volatilities and stock-bond return correlations. They also provide an alternative derivation for a measure of time-varying disaster risk suggested by Wachter (2013), implying that both the disaster and the long-run risk paradigm can be extended towards explaining movements in the stock-bond correlation.


Bundesbank Discussion Paper No. 33/2020

featured in: VoxEU column 2022, Bundesbank Research Brief 44/2021

Presented at: AFA 2020 Poster Session (San Diego), Bundesbank Spring Conference 2019, Conference on Systemic Risk and Financial Stability (University Freiburg), Workshop on Monetary and Financial Macroeconomics 2019 (Hamburg)

Abstract: We operationalize the definition of systemic risk provided by the IMF, BIS, and FSB and derive a two-stage hierarchical hypothesis test to identify indicators of systemic risk. Applying the framework to a set of candidate variables for 45 countries, we detect two credit-based financial cycle variables that, by and large, pass our test. However, for many other variables, including the Basel III credit-to-GDP gap, we find that elevated systemic risk is signaled by high values in some countries and by low values in others. More generally, our results suggest that, ex ante, systemic risk can be clearly identified only once the turning points of indicators have been observed.


SAFE Working Paper No. 74, Bundesbank Discussion Paper No. 37/2018

Abstract: Directed links in cash flow networks affect the cross-section of risk premia through three channels. In a tractable consumption-based equilibrium asset pricing model, we obtain closed-form solutions that disentangle these channels for arbitrary directed networks. First, shocks that can propagate through the economy command a higher market price of risk. Second, shock-receiving assets earn an extra premium since their valuation ratios drop upon shocks in connected assets. Third, a hedge effect pushes risk premia down: when a shock propagates through the economy, an asset that is unconnected becomes relatively more attractive and its valuation ratio increases.


Abstract: It is a major challenge for asset pricing models to generate a high equity premium and a low risk-free rate while imposing realistic consumption dynamics. To address this issue, our paper proposes a novel pricing channel: We allow for consumption drops that can spark an economic crisis. This new feature generates a large equity premium even if possible consumption drops are of moderate size. In turn, our model also matches the consumption data of 42 countries along several dimensions. In particular, our approach generates a realistic number of crises that have realistic durations and involve clustering of moderate consumption drops.


Abstract: This paper compares two classes of models that allow for additional channels of correlation between asset returns: regime switching models with jumps and models with contagious jumps. Both classes of models involve a hidden Markov chain that captures good and bad economic states. The distinctive feature of a model with contagious jumps is that large negative returns and unobservable transitions of the economy into a bad state can occur simultaneously. We show that in this framework the filtered loss intensities have dynamics similar to self-exciting processes. Besides, we study the impact of unobservable contagious jumps on optimal portfolio strategies and filtering.


Abstract: We study the impact of financial contagion on the dynamic asset allocation problem of a CRRA investor facing an incomplete market with two risky assets. We apply a Markov chain regime-switching framework with state-dependent jump intensities, diffusion volatilities and diffusion correlations. The key model feature that a switch to the bad contagion regime is triggered by a loss in one of the risky assets allows for the implementation of a hedging demand against contagion risk. Moreover, a state-dependent diffusion correlation combined with heterogeneity in jump intensities and volatilities can, e.g., generate a flight to quality effect upon a systemic jump.


Abstract: This paper provides a detailed overview of the current research linking systemic risk, financial crises and contagion effects among assets on the one hand with asset allocation and asset pricing theory on the other hand. Based on the ample literature about definitions, measurement and properties of systemic risk, we derive some elementary ingredients for models of financial contagion and assess the current state of knowledge about asset allocation and asset pricing with explicit focus on systemic risk. The paper closes with a brief outlook on future research possibilities and some recommendations for the further development of capital market models incorporating financial contagion.


Abstract: Stocks are exposed to the risk of sudden downward jumps. Additionally, a crash in one stock (or index) can increase the risk of crashes in other stocks (or indices). Our paper explicitly takes this contagion risk into account and studies its impact on the portfolio decision of a CRRA investor both in complete and in incomplete market settings. We find that the investor significantly adjusts his portfolio when contagion is more likely to occur. Capturing the time dimension of contagion, i.e. the time span between jumps in two stocks or stock indices, is thus of first-order importance when analyzing portfolio decisions. Investors ignoring contagion completely or accounting for contagion while ignoring its time dimension suffer large and economically significant utility losses. These losses are larger in complete than in incomplete markets, and the investor might be better off if he does not trade derivatives. Furthermore, we emphasize that the risk of contagion has a crucial impact on investors' security demands, since it reduces their ability to diversify their portfolios.

Work in Progress

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