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Local Thinking and Skewness Preferences

Markus Dertwinkel-Kalt and Mats Köster
University of Cologne, Working Paper Series in Economics No. 97, 2017

We show that continuous models of stimulus-driven attention can account for skewness-related puzzles in decision-making under risk. First,we delineate that these models provide awell-defined theory of choice under risk. We therefore prove that in continuous—in contrast to discrete—models of stimulus-driven attention each lottery has a unique certainty equivalent that is monotonic in probabilities (i.e., it monotonically increases if probability mass is shifted to more favorable outcomes). Second, we show that whether an agent seeks or avoids a specific risk depends on the skewness of the underlying probability distribution. Since unlikely, but outstanding payoffs attract attention, an agent exhibits a preference for right-skewed and an aversion toward left-skewed risks. While cumulative prospect theory can also account for such skewness preferences, it yields implausible predictions on their magnitude. We show that these extreme implications can be ruled out for continuous models of stimulus-driven attention.

PDF Local Thinking and Skewness Preferences

Interest Rate Spreads and Forward Guidance

Christian Bredemeier, Christoph Kaufmann and Andreas Schabert
University of Cologne, Working Paper Series in Economics No. 96, 2017

Announcements of future monetary policy rate changes have been found to be imperfectly passed through to various interest rates. We provide evidence for rates of return on less liquid assets to respond by less than, e.g., treasury rates to forward guidance announcements of the US Federal Reserve, suggesting that single-interest-rate models tend to overestimate their macroeconomics effects. We apply a macroeconomic model with interest rate spreads stemming from differential pledgeability of assets, implying that assets provide liquidity services to different extents. Consistent with empirical evidence, announcements of future reductions in the policy rate lead to an increase in liquidity premia. The output effects of forward guidance do not increase with length of the guidance period and are substantially less pronounced than they are predicted to be by a standard New Keynesian model. We thereby provide a solution to the so-called ”forward guidance puzzle”.

PDF Interest Rate Spreads and Forward Guidance

Fiscal Multipliers and Monetary Policy: Reconciling Theory and Evidence

Christian Bredemeier, Falko Juessen and Andreas Schabert
University of Cologne, Working Paper Series in Economics No. 95, 2017

Fiscal multipliers are typically observed to be moderate, which should, according to standard macroeconomic theory, be associated with real interest rates increasing with government spending. However, monetary policy rates have been found to decrease, which should – in theory – lead to large multipliers. In this paper, we rationalize these puzzling observations by accounting for responses of interest rates that are more relevant for private sector transactions than the monetary policy rate. We provide evidence that real interest rates on relatively illiquid assets and interest rate spreads which measure liquidity premia tend to increase after a government spending hike. We show that an otherwise standard macro model can explain diverging interest rate responses and moderate fiscal multipliers consistent with the data by accounting for an interest rate spread that decreases with the relative demand for less liquid assets. Our analysis indicates that neither a policy rate reduction nor a fixation at the zero lower bound are sufficient to induce large fiscal multipliers.

PDF Fiscal Multipliers and Monetary Policy: Reconciling Theory and Evidence

Welfare-Enhancing Distributional Effects of Central Bank Asset Purchases

Andreas Schabert
University of Cologne, Working Paper Series in Economics No. 94, 2017

This paper shows that central bank interventions in secondary markets for private debt can enhance social welfare. We apply a model with idiosyncratic risk and limited contract enforcement, while abstracting from unusually large disruptions in financial market. By purchasing debt at above-market prices the central bank induces an increase in credit supply, by which rather borrowers than debt holders gain. We show that asset purchases can not only replicate a tax/subsidy that addresses pecuniary externalities induced by a collateral constraint, but can even improve upon the constrained efficient allocation. We further demonstrate that countercyclical asset purchases are desirable under aggregate risk, which reduce the build-up of debt in favorable times.

PDF Welfare-Enhancing Distributional Effects of Central Bank Asset Purchases

Do Price-Matching Guarantees with Markups Facilitate Tacit Collusion? Theory and Experiment

Andreas Pollak
University of Cologne, Working Paper Series in Economics No. 93, 2017

This paper studies how competitive prices are affected by price-matching guarantees allowing for markups on the lowest competing price. This new type of low-price guarantee was recently introduced in the German retail gasoline market. Using a sequential Hotelling model, we show that such guarantees, similar to perfect price-matching guarantees, can induce collusive prices. In particular, this occurs if the first mover provides a price guarantee with a markup which is below a threshold value. In these cases, prices are on average set at the monopoly level. A laboratory experiment supports the theoretical predictions.

PDF Do Price-Matching Guarantees with Markups Facilitate Tacit Collusion? Theory and Experiment

Evasive Lying in Strategic Communication

Kiryl Khalmetski, Bettina Rockenbach and Peter Werner
University of Cologne, Working Paper Series in Economics No. 92, 2017

Information asymmetries in economic transactions are omnipresent and a regular source of fraudulent behavior. In a theoretical and an experimental analysis of a sender-receiver game we investigate whether sanctions for lying induce more truthtelling. The novel aspect in our model is that senders may not only choose between truth-telling and (explicit) lying, but may also engage in evasive lying by credibly pretending not to know. While we find that sanctions promote truth-telling when senders cannot engage in evasive lying, this is no longer true when evasive lying is possible. Then, explicit lying is largely substituted by evasive lying, which completely eliminates the otherwise positive effect of sanctions on the rate of truthtelling. As outlined in our model, the necessary prerequisite for such an ‘erosion’ effect is that evasive lying is perceived as sufficiently less psychologically costly than direct lying. Our results clearly demonstrate the limitations of sanctioning lying to counteract the exploitation of informational asymmetries and may explain the empirical evidence from the finance industry that sanctions for financial misconduct eventually appear to be not very efficient.

PDF Evasive Lying in Strategic Communication

Incorporation Decisions and Job Creation in New Firms

Susanne Prantl and Frederik Thenée
University of Cologne, Working Paper Series in Economics No. 91, 2017

The regulation of firms can influence job creation in new firms, and these influences may contribute to long-term effects on the economy-wide distribution of jobs across firms. In this paper, we study the influences on job creation in new firms that follow from incorporation law, specifically the law-induced cost at firm entry. To identify these influences empirically, we allow for endogenous decisions on incorporation and, in addition, exploit a natural experiment in regulation that accompanied German reunification. Our empirical findings are in line with predictions that we derive from the model of Lucas (1978) by integrating incorporation decisions. We show that an increase in incorporation-related entry cost reduces the emergence of incorporated firms in a population of new firms. In addition, such an increase leads to higher initial job creation in incorporated than in unincorporated firms and decreases the mass of the entry size distribution across incorporations relative to the distribution across unincorporated firms in the intermediate range.

Incorporation Decisions and Job Creation in New Firms

Sharing Guilt

Roman Inderst, Kiryl Khalmetski and Axel Ockenfels
University of Cologne, Working Paper Series in Economics No. 90, 2017

Keywords:Shared guilt, trust, guilt aversion, responsibility diffusion, financial advice

We provide laboratory evidence that the attribution of guilt for disappointed trust is shared between the players whose choices eventually contributed to this disappointment (including the disappointed player herself). We refer to this as "shared guilt" and present a model that captures the phenomenon, and which is consistent with various previous findings. We also discuss potential policy implications.

Sharing Guilt