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NBER Reporter NATIONAL BUREAU of ECONOMIC RESEARCH NBER Reporter NATIONAL BUREAU OF ECONOMIC RESEARCH A quarterly summary of NBER research No. 2, June 2018 Program Report ALSO IN THIS ISSUE Potential Gains from Delaying Social Security until Age 70 A couple, assumed to both be age 62, earning the average wage will gain $151,078 Asset Pricing Program by delaying Social Security until they are 70 years old Thousands of U.S. dollars 250 High earner (160% of avg. wage) 200 Medium earner (avg. wage) Monika Piazzesi * Low earner (45% of avg. wage) 150 100 50 The 2007–09 financial crisis challenged many long-standing beliefs 0 about asset markets. For example, it raised questions about the applicabil- 62 63 64 65 66 67 68 69 Age ity of the law of one price, it coincided with a period of extraordinary house Source: G. Bronshtein, J. Scott, J. B. Shoven, and S. N. Slavov, NBER Working Paper No. 22853 price volatility, and it witnessed changing patterns of asset demand on the part of households and financial institutions alike. Over the last decade, researchers in the Asset Pricing Program have carried out a wide range of Implicit Taxes on Work at Older Ages 7 studies that are motivated by, or try to respond to, these challenges. This report focuses on studies that exemplify post-crisis research on The Shrinking Universe of Public Firms: these three specific developments. The report is not a comprehensive review Facts, Causes, and Consequences 12 of research in the three areas, but is rather a collection of illustrative stud- The Competitive Saving Motive in China ies. Many other related papers have been distributed in the NBER Working Implications for Savings, the Current Account, Papers series. and Housing Prices 16 Exploring Violations of the Law of One Price Firm Learning and Market Equilibrium 21 The law of one price holds that two investment strategies that have NBER News 24 exactly the same payoffs in the future should have the same value today. This principle is at the core of asset pricing theory and is usually taught Conferences 25 at the beginning of any course in finance. Before the crisis, the law of one price was extraordinarily useful for thinking about financial markets. It was Program and Working Group Meetings 31 hard to come up with examples of buy-sell strategies that would generate profitable arbitrages, at least after accounting for the transaction costs that NBER Books 38 would be involved in trading based on these strategies. This suggested that violations of the law of one price did not exist, or that if they did, they were short-lived and quickly arbitraged away. The crisis profoundly changed this situation, as the law of one price appeared to be violated in many settings. Why? The standard explana- * Monika Piazzesi, the Joan Kenney Professor of Economics at Stanford University, is director of the NBER’s Asset Pricing Program and co-orga- nizer of the NBER conference series New Developments in Long-term Asset Management. Reporter Online at: www.nber.org/reporter tion has been weak balance sheets: Financial institutions were aware of the arbitrage oppor- NBER Reporter tunities but were unable to take the positions necessary to eliminate them. Some violations have persisted and are still observed today, even though balance sheets of financial institutions The National Bureau of Economic Research is a private, nonprofit research orga- nization founded in 1920 and devoted to objective quantitative analysis of the have recovered. American economy. Its officers and board of directors are: There have been particularly salient ques- President and Chief Executive Officer — James M. Poterba tions about price determination in foreign Controller — Kelly Horak exchange markets. In these markets, the law of Corporate Secretary — Alterra Milone one price implies the covered interest rate par- BOARD OF DIRECTORS ity (CIP) condition. It compares two investment Chair — Karen N. Horn strategies that do not involve risk. For example, Vice Chair — John Lipsky one might be investing U.S. dollars domestically Treasurer — Robert Mednick at the short-term interest rate, while the other DIRECTORS AT LARGE could be investing dollars in Switzerland at the Peter Aldrich Mohamed El-Erian Karen Mills same maturity. In the latter case, the investor Elizabeth E. Bailey Jacob A. Frenkel Michael H. Moskow would exchange dollars for Swiss francs today, John H. Biggs Robert S. Hamada Alicia H. Munnell John S. Clarkeson Peter Blair Henry Robert T. Parry invest the francs at the Swiss short-term rate, Kathleen B. Cooper Karen N. Horn James M. Poterba and then convert them back into dollars at the Charles H. Dallara Lisa Jordan John S. Reed current futures exchange rate. The CIP condi- George C. Eads John Lipsky Marina v. N. Whitman Jessica P. Einhorn Laurence H. Meyer Martin B. Zimmerman tion states that the return on these two strategies should be the same. Wenxin Du, Alexander Tepper, and Adrien DIRECTORS BY UNIVERSITY APPOINTMENT Verdelhan document that the CIP condition Timothy Bresnahan, Stanford Benjamin Hermalin, California, Berkeley held up well before the crisis, but broke down Pierre-André Chiappori, Columbia George Mailath, Pennsylvania 1 Alan V. Deardorff, Michigan Marjorie B. McElroy, Duke afterward in the markets for G-10 currencies. Ray C. Fair, Yale Joel Mokyr, Northwestern Figure 1, on the next page, shows these violations Edward Foster, Minnesota Cecilia Elena Rouse, Princeton in basis points. For most currencies, including John P. Gould, Chicago Richard L. Schmalensee, MIT Mark Grinblatt, California, Los Angeles Ing o Wa l t er, New York University the Swiss franc, the Japanese yen, and the euro, Bruce Hansen, Wisconsin-Madison David B. Yoffie, Harvard it is more profitable to borrow abroad and invest DIRECTORS BY APPOINTMENT OF OTHER ORGANIZATIONS domestically. Jean-Paul Chavas, Agricultural and Applied Economics Association The researchers find evidence that regula- Martin Gruber, American Finance Association tory constraints, in particular capital require- Philip Hoffman, Economic History Association ments for European banks, are responsible for Arthur Kennickell, American Statistical Association Jack Kleinhenz, National Association for Business Economics the CIP violations. European banks have to Robert Mednick, American Institute of Certified Public Accountants hold capital against quarter-end positions. The Peter L. Rousseau, American Economic Association researchers also observe stronger CIP violations Gregor W. Smith, Canadian Economics Association William Spriggs, American Federation of Labor and toward the end of the quarter. A week from the Congress of Industrial Organizations end of the quarter, for example, European banks Bart van Ark, The Conference Board do not like to engage in weeklong positions. The NBER depends on funding from individuals, corporations, and private Figure 2, also on the next page, shows the pat- foundations to maintain its independence and its flexibility in choosing its tern of the CIP deviations in forward contracts research activities. Inquiries concerning contributions may be addressed to James toward the end of the quarter. M. Poterba, President & CEO, NBER, 1050 Massachusetts Avenue, Cambridge, MA 02138-5398. All contributions to the NBER are tax-deductible. Du, Joanne Im, and Jesse Schreger point to another cause for CIP violations: the attractive- The Reporter is issued for informational purposes and has not been reviewed by ness of U.S. Treasuries as safe assets for inves- the Board of Directors of the NBER. It is not copyrighted and can be freely repro- tors across the world.2 They document large duced with appropriate attribution of source. Please provide the NBER’s Public Information Department with copies of anything reproduced. and persistent CIP violations when rates are measured from government bonds instead of Requests for subscriptions, changes of address, and cancellations should be sent LIBOR. Foreign investors appear willing to to Reporter, National Bureau of Economic Research, Inc., 1050 Massachusetts Avenue, Cambridge, MA 02138-5398 (please include the current mailing label), give up roughly 25 basis points per year to hold or by email to [email protected]. Print copies of the Reporter are only mailed to currency-hedged U.S. Treasuries as opposed to subscribers in the U.S. and Canada; those in other nations may request electronic their own countries’ bonds. subscriptions at www.nber.org/drsubscribe/. 2 NBER Reporter • No. 2, June 2018 Deviation from Covered-Interest Parity for Three-Month LIBOR, Various Cross Currencies 10-day moving average (basis points) 50 50 50 50 50 0 0 0 0 0 AUD CAD CHF DKK EUR −250 −250 −250 −250 −250 2000 2008 2016 2000 2008 2016 2000 2008 2016 2000 2008 2016 2000 2008 2016 50 50 50 50 50 0 0 0 0 0 GBP JPY NOK NZD SEK −250 −250 −250 −250 −250 2000 2008 2016 2000 2008 2016 2000 2008 2016 2000 2008 2016 2000 2008 2016 Source: W. Du, A. Tepper, and A. Verdelhan, NBER Working Paper No. 23170 Figure 1 U.S. Treasuries are well known to be House Prices data is usually costly, because individual sought after as a safe asset. As a conse- housing transactions and mortgage infor- quence, they have a convenience yield: Before the dramatic boom-bust epi- mation are only available through com- their holders accept a lower interest rate sode of the early 2000s, housing markets mercial data providers such as CoreLogic. than they could earn on other bonds attracted relatively little attention from These data need to be cleaned with many because the Treasuries are more liquid asset pricing researchers. This was due, in filters to eliminate transactions that were than other bonds. The presence of the part, to data availability. Researchers have not made at market prices or that should convenience yield leads to CIP violations easy access to copious data on individual be excluded for other reasons. We would even in the absence of financial frictions stocks through the Center for Research in know more today about booms and busts such as regulatory constraints, but during Security Prices (CRSP), while researchers in housing markets if there was a CRSP and after the crisis, the yield differential studying house prices often must begin database for housing and mortgages.
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