Optimal Taxation in Asset Markets with Adverse SelectionMohammad Davoodalhosseini
"Consider markets for assets traded over the counter such as mortgage-backed securities and corporate bonds. Sellers in these markets may have more information on the value of their assets and their liquidity needs than buyers do. Also, sellers and buyers must search for trade partners, which is time-consuming and costly. During the 2007–09 financial crisis, activity in some of these markets declined to close to zero, and governments and central banks undertook various policies to...
Identifying Consumer-Welfare Changes when Online Search Platforms Change Their List of Search ResultsRyan Martin
"Online shoppers are guided by search platforms: consumers type a search phrase into the platform’s query box, and the platform chooses how products appear in response. While search platforms may choose responses that help consumers find products more efficiently, they may also have incentives to mislead consumers. For example, search platforms may organize responses to favor their own products over third-party products that better suit consumer needs. This paper uses a search-platform experiment to determine...
Dynamic Competition in Negotiated Price MarketsJason Allen & Shaoteng Li
"In many credit markets, prices are negotiated repeatedly. The final mortgage rate, for example, is rarely the posted price, but something that borrowers and lenders have bargained over. If borrowers are not satisfied with the rates their lenders propose, they need to search for and negotiate better offers. Borrowers often find it costly and inconvenient to switch lenders. The search and switching costs give incumbent lenders a clear advantage, allowing them to charge relatively high...
On Causal Networks of Financial Firms: Structural Identification via Non-parametric HeteroskedasticityRuben Hipp
Various business interactions of banks create a network of hidden relationships, which cannot be directly inferred from the correlation of bank stock returns. Without causality, it remains unclear how policy interventions change the network. Thus, this paper aims to find the causal network as anticipated by investors.
Monetary Policy Independence and the Strength of the Global Financial CycleChristian Friedrich, Pierre Guérin & Danilo Leiva-Leon
We propose a new strength measure of the global financial cycle by estimating a regime-switching factor model on cross-border equity flows for 61 countries. We then assess how the strength of the global financial cycle affects monetary policy independence, which is defined as the response of central banks' policy interest rates to exogenous changes in inflation.
Forward Guidance and Expectation Formation: A Narrative ApproachChristopher Sutherland
"Forward guidance is a central bank statement that provides direct information about the probable state of monetary policy in the future. Its purpose is to influence interest rate expectations. But how exactly does it do so? To study this issue, I construct central bank data that includes forward guidance and its attributes, central bank projections and quantitative easing, which I then combine with survey data. I find that, in response to a change in forward...
Endogenous Time Variation in Vector AutoregressionsDanilo Leiva-Leon & Luis Henrique Uzeda Garcia
We introduce a new class of time-varying parameter vector autoregressions (TVP-VARs) where the identified structural innovations are allowed to influence — contemporaneously and with a lag — the dynamics of the intercept and autoregressive coefficients in these models. An estimation algorithm and a parametrization conducive to model comparison are also provided. We apply our framework to the US economy. Scenario analysis suggests that the effects of monetary policy on economic activity are larger and more...
A Simple Method for Extracting the Probability of Default from American Put Option PricesBo Young Chang & Greg Orosi
A put option is a financial contract that gives the holder the right to sell an asset at a specific price by (or at) a specific date. A put option can therefore provide its holder insurance against a large drop in the stock price. This makes the prices of put options an ideal source of information for a market-based measure of the probability of a firm’s default.
The potential effect of a central bank digital currency on deposit funding in CanadaAlejandro García, Bena Lands, Xuezhi Liu & Joshua Slive
A retail central bank digital currency denominated in Canadian dollars could, in theory, create competition for bank deposit funding.
Learning, Equilibrium Trend, Cycle, and Spread in Bond YieldsGuihai Zhao
"Given that the stochastic discount factor (SDF) from any equilibrium model has direct implications for yield curves, the historical dynamics of the US Treasury yield curve should tell us what a good SDF should look like from a historical perspective. Some key features in the US Treasury bond yields—the trends in the long-term yields, business-cycle movements in the short-term yields and level shifts in the yield spreads—pose serious challenges to existing equilibrium asset pricing models....
Monetary Policy Implementation and Payment System ModernizationJonathan Witmer
"Canada plans to adopt a retail payment system to allow Canadians to pay in real time (or near real time) 24 hours a day, 7 days a week. However, the traditional model for setting the overnight interest rate does not operate 24/7. In this paper, we adapt the traditional model to include paying after hours when participants do not have access to central bank lending and deposit facilities. If they do not have access to...
Monetary Policy and Cross-Border Interbank Market Fragmentation: Lessons from the CrisisTobias Blattner & Jonathan Swarbrick
We present a two-country model featuring risky lending and cross-border interbank market frictions. We find that (i) the strength of the financial accelerator, when applied to banks operating under uncertainty in an interbank market, will critically depend on the economic and financial structure of the economy; (ii) adverse shocks to the real economy can be the source of banking crisis, causing an increase in interbank funding costs, aggravating the initial shock; and (iii) asset purchases...
The New Benchmark for Forecasts of the Real Price of Crude OilAmor Aniss Benmoussa, Reinhard Ellwanger & Stephen Snudden
How can we assess the quality of a forecast? We propose a new benchmark to evaluate forecasts of temporally aggregated series and show that the real price of oil is more difficult to predict than we thought.
Why Fixed Costs Matter for Proof-of-Work Based CryptocurrenciesRod Garratt & Maarten van Oordt
"Ensuring that the record of Bitcoin transactions is secure uses a lot of computational power. Miners, who supply this power to the Bitcoin network, earn transaction fees and new bitcoins. Ultimately, though, bitcoin miners will earn only fees as the number of new bitcoins slowly declines to zero. As mining rewards wane, some experts say that Bitcoin will become vulnerable to attacks. Will Bitcoin transactions remain secure in the future? Our analysis focuses on the...
Non-competing Data IntermediariesShota Ichihashi
I study a model of competing data intermediaries (e.g., online platforms and data brokers) that collect personal data from consumers and sell it to downstream firms. Competition in this market has a limited impact in terms of benefits to consumers: If intermediaries offer high compensation for their data, then consumers may share this data with multiple intermediaries, and this lowers its downstream price and hurts intermediaries. As intermediaries anticipate this problem, they offer low compensation...
The Power of Helicopter Money Revisited: A New Keynesian PerspectiveThomas J. Carter & Rhys R. Mendes
"We analyze money financing of fiscal transfers (helicopter money) in two simple New Keynesian models: a “textbook” model in which all money is non-interest-bearing (e.g., all money is currency), and a more realistic model with interest-bearing reserves. In the textbook model with only non-interest-bearing money, we find the following: A money-financed fiscal expansion can be more stimulative than a debt-financed fiscal expansion of equal magnitude. However, the extra stimulus requires that the central bank abandon...
CBDC and Monetary PolicySeyed Mohammadreza Davoodalhosseini, Francisco Rivadeneyra & YU ZHU
Improving the conduct of monetary policy is unlikely to be the main motivation for central banks to issue a central bank digital currency (CBDC). While some argue that a CBDC could allow more complex transfer schemes or the ability to break below the zero lower bound, we find these benefits might be small or difficult to realize in practice.
The Canadian corporate investment gapChristopher D'Souza, Timothy Grieder, Daniel Hyun & Jonathan Witmer
Business investment has been lower than expected in Canada and abroad since the financial crisis of 2007–09. This corporate investment gap is mirrored in firms’ other financing decisions, as they have increased cash holdings and dividend payments and decreased issuance of debt and equity.
Classical Decomposition of Markowitz Portfolio SelectionChristopher Demone, Olivia Di Matteo & Barbara Collignon
In this study, we enhance Markowitz portfolio selection with graph theory for the analysis of two portfolios composed of either EU or US assets. Using a threshold-based decomposition of their respective covariance matrices, we perturb the level of risk in each portfolio and build the corresponding sets of graphs.
Ten Isn’t Large! Group Size and Coordination in a Large-Scale ExperimentJasmina Arifovic, Cars Hommes, Anita Kopányi-Peuker & isabelle salle
"Economic activities typically involve coordination among a large number of agents. These agents have to anticipate what other agents think before making their own decisions. Agents may fail to arrive at the best outcome simply because they believe that the others will fail to reach the same outcome. These situations are not uncommon: bank runs, liquidity runs in financial markets or currency attacks may all result from depositors and investors simply believing that others will...
Managing GDP Tail RiskThibaut Duprey & Alexander Ueberfeldt
Models for macroeconomic forecasts do not usually take into account the risk of a crisis—that is, a sudden large decline in gross domestic product (GDP). However, policy-makers worry about such GDP tail risk because of its large social and economic costs. Our practical framework provides monetary and macroprudential policy-makers with guidance on the trade-off between GDP tail risk and the most likely growth path for future GDP. Focusing on Canada, we compare the effectiveness of...
Household indebtedness risks in the wake of COVID‑19Olga Bilyk, Anson T. Y. Ho, Mikael Khan & Geneviève Vallée
COVID-19 presents challenges for indebted households. We assess these by drawing parallels between pandemics and natural disasters. Taking into account the financial health of the household sector when the pandemic began, we run model simulations to illustrate how payment deferrals and the labour market recovery will affect mortgage defaults.
Demand for Payment Services and Consumer Welfare: The Introduction of a Central Bank Digital CurrencyKim Huynh, Jozsef Molnar, Oleksandr Shcherbakov & Qinghui Yu
In recent years, there have been rapid technological innovations in retail payments. Such dramatic changes in the economics of payment systems have led to questions regarding whether there is consumer demand for cash. The entry of these new products and services has resulted in significant improvements in the characteristics of existing methods of payment, such as tap-and-go technology or contactless credit and debit cards. In addition, the introduction of decentralized digital currencies has raised questions...
Scenario Analysis and the Economic and Financial Risks from Climate ChangeErik Ens & Craig Johnston
This paper adapts climate-economy models that have been applied in other contexts for use in climate-related scenario analysis. We consider illustrative scenarios for the global economy that could generate economic and financial risks. Our results suggest there are significant economic risks from climate change and the move to a low-carbon economy.
2019 Cash Alternative Survey ResultsKim Huynh, Gradon Nicholls & Mitchell Nicholson
The role of cash in Canadians’ lives has been evolving, as innovations in digital payments have become more widely adopted over the past decade. We contribute to the Bank of Canada’s research on central bank digital currency by monitoring Canadians’ use of cash and their adoption of digital payment methods.