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Working Papers 2019: Abstracts

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19-55: Population Aging, Credit Market Frictions, and Chinese Economic Growth by Michael Dotsey, Wenli Li, and Fang Yang

We build a unified framework to quantitatively examine population aging and credit market frictions in contributing to Chinese economic growth between 1977 and 2014. We find that demographic changes together with endogenous human capital accumulation account for a large part of the rise in per capita output growth, especially after 2007, as well as some of the rise in savings. Credit policy changes initially alleviate the capital misallocation between private and public firms and lead to significant increases in both savings and output growth. Later, they distort capital allocation. While contributing to further increase in savings, the distortion slows down economic growth. Among factors that we consider, increased life expectancy and financial development in the form of reduced intermediation cost are the most important in driving the dynamics of savings and growth.

Supersedes Working Paper 19-21.
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19-54: Financial Consequences of Health Insurance: Evidence from the ACA’s Dependent Coverage Mandate by Nathan Blascak and Vyacheslav Mikhed

We study the financial effects of health insurance for young adults using the Affordable Care Act’s dependent coverage mandate as a source of exogenous variation. Using nationally representative, anonymized credit report and publicly available survey data on medical expenditures, we exploit the mandate’s implementation in 2010 and its automatic disenrollment mechanism at age 26. Our estimates show that increasing access to health insurance lowered young adults’ out-of-pocket medical expenditures, debt in third-party collections, and the probability of personal bankruptcy. However, most improvements in financial outcomes are transitory, as they diminish after an individual ages out of the mandate at age 26.
Supersedes Working Paper 18-03.
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19-53: Owner-Occupancy Fraud and Mortgage Performance by Ronel Elul, Aaron Payne, and Sebastian Tilson

We use a matched credit bureau and mortgage dataset to identify occupancy fraud in residential mortgage originations, that is, borrowers who misrepresented their occupancy status as owner-occupants rather than residential real estate investors. In contrast to previous studies, our dataset allows us to show that – during the housing bubble – such fraud was broad based, appearing in the government-sponsored enterprise market and in loans held on bank portfolios as well, and increases the effective share of investors by 50 percent. We show that a key benefit of investor fraud was obtaining a lower interest rate, particularly for riskier borrowers. Mortgage borrowers who misrepresented their occupancy status performed substantially worse than otherwise similar owner-occupants and declared investors, and constituted one-sixth of the share of loans in default by the end of 2008. We show that these defaults were also significantly more likely to be “strategic,” further highlighting the contribution of fraud in the housing bust.
Supersedes Working Paper 15-45.
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19-52: Financial Constraints of Entrepreneurs and the Self-Employed by Vyacheslav Mikhed, Sahil Raina, and Barry Scholnick

Growth-oriented entrepreneurial start-ups generate more economic growth than other self-employed businesses, yet they only constitute a small fraction of start-ups. We examine whether financial constraints impede these types of start-ups by exploiting lottery wins as exogenous wealth shocks. We find that lottery-win magnitude increases winners’ subsequent incorporation, implying that entrepreneurs face financial constraints, but not business registration, implying that financial constraints do not bind as much for the self-employed. Our results, that financial constraints bind for incorporations among men, for serial entrepreneurs, during economic booms, and in neighborhoods without local lenders, are important for understanding the financial impediments to entrepreneurial start-ups.
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19-51: Bayesian Estimation and Comparison of Conditional Moment Models by Siddhartha Chib, Minchul Shin, and Anna Simoni

We provide a Bayesian analysis of models in which the unknown distribution of the outcomes is specified up to a set of conditional moment restrictions. This analysis is based on the nonparametric exponentially tilted empirical likelihood (ETEL) function, which is constructed to satisfy a sequence of unconditional moments, obtained from the conditional moments by an increasing (in sample size) vector of approximating functions (such as tensor splines based on the splines of each conditioning variable). The posterior distribution is shown to satisfy the Bernstein-von Mises theorem, subject to a growth rate condition on the number of approximating functions, even under misspecification of the conditional moments. A large-sample theory for comparing different conditional moment models is also developed. The central result is that the marginal likelihood criterion selects the model that is less misspecified, that is, the model that is closer to the unknown true distribution in terms of the Kullback-Leibler divergence. Several examples are provided to illustrate the framework and results.
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19-50: Home Equity in Retirement by Makoto Nakajima and Irina A. Telyukova

Retired homeowners dissave more slowly than renters, which suggests that homeownership affects retirees' saving decisions. We investigate empirically and theoretically the life-cycle patterns of homeownership, housing and nonhousing assets in retirement. Using an estimated structural model of saving and housing decisions, we find, first, that homeowners dissave slowly because they prefer to stay in their house as long as possible but cannot easily borrow against it. Second, the 1996–2006 housing boom significantly increased homeowners' assets. These channels are quantitatively significant; without considering homeownership, retirees' net worth would be 28–44 percent lower, depending on age.
Supersedes Working Paper 11-15.
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19-49: Fast Locations and Slowing Labor Mobility by Patrick Coate and Kyle Mangum

Declining internal migration in the United States is driven by increasing home attachment in locations with initially high rates of population turnover. These “fast” locations were the population growth destinations of the 20th century, where home attachments were low, but have increased as regional population growth has converged. Using a novel measure of attachment, this paper estimates a structural model of migration that distinguishes moving frictions from home utility. Simulations quantify candidate explanations of the decline. Rising home attachment accounts for most of the decline not attributable to population aging, and its effect is consistent with the observed spatial pattern.
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19-48: Credit, Bankruptcy, and Aggregate Fluctuations by Makoto Nakajima and José-Víctor Ríos-Rull

We document the cyclical properties of unsecured consumer credit (procyclical and volatile) and of consumer bankruptcies (countercyclical and very volatile). Using a growth model with household heterogeneity in earnings and assets with access to unsecured credit (because of bankruptcy costs) and aggregate shocks, we show that the cyclical behavior of household earnings growth accounts for these properties, albeit not for the large volatility of credit. We find that tilting household consumption towards goods that can be purchased on credit and a slight countercyclicality in the terms of access to credit match the sizes of credit and bankruptcy volatilities. We also find that when the right to file for bankruptcy does not exist unsecured credit is countercyclical.
Supersedes Working Paper 14-31.
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19-47: Fintech Lending and Mortgage Credit Access by Julapa Jagtiani, Lauren Lambie-Hanson, and Timothy Lambie-Hanson

Following the 2008 financial crisis, mortgage credit tightened and banks lost significant mortgage market share to nonbank lenders, including to fintech firms recently. Have fintech firms expanded credit access, or are their customers similar to those of traditional lenders? Unlike in small business and unsecured consumers lending, fintech mortgage lenders do not have the same incentives or flexibility to use alternative data for credit decisions because of stringent mortgage origination requirements. Fintech loans are broadly similar to those made by traditional lenders, despite innovations in the marketing and the application process. However, nonbanks market to consumers with weaker credit scores than do banks, and fintech lenders have greater market shares in areas with lower credit scores and higher mortgage denial rates.
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19-46: Personal Bankruptcy as a Real Option by Guozhong Zhu, Vyacheslav Mikhed, and Barry Scholnick

We provide a novel explanation to the longstanding puzzle of the "missing bankruptcy filings." Even though a household with a negative net worth will receive contemporaneous benefit from bankruptcy, there may be greater insurance value from delaying the filing. Household bankruptcy is thus an American-style put option, which is not necessarily exercised even if the option is "in the money." Based on the value functions in the household's dynamic programming problem, we formulate the value of the bankruptcy option as well as the exercise price. We estimate a life-cycle model in which households choose the optimal time to exercise their bankruptcy option.
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19-45: Institutional Investors and the U.S. Housing Recovery by Lauren Lambie-Hanson, Wenli Li, and Michael Slonkosky

We study the house price recovery in the U.S. single-family residential housing market since the outbreak of the mortgage crisis, which, in contrast to the preceding housing boom, was not accompanied by a rise in homeownership rates. Using comprehensive property-level transaction data, we show that this phenomenon is largely explained by the emergence of institutional investors. By exploiting heterogeneity in a county's exposure to local lending conditions and to government programs that affected investors' access to residential properties, we estimate that the increasing presence of institutions in the housing market explains over half of the increase in real house price appreciation rates between 2006 and 2014. We further demonstrate that institutional investors contribute to the improvement of the local housing market by reducing vacancy rates as they shorten the amount of time distressed properties stay in REO. Additionally, institutional investors help lower local unemployment rates by increasing local construction employment. However, institutional investors are responsible for most of the declines in the homeownership rates.
Supersedes Working Paper 19-01.
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19-44: Heterogeneity in Decentralized Asset Markets, by Julien Hugonnier, Benjamin Lester, and Pierre-Olivier Weill

We study a search and bargaining model of asset markets in which investors’ heterogeneous valuations for the asset are drawn from an arbitrary distribution. We present a solution technique that makes the model fully tractable, and allows us to provide a complete characterization of the unique equilibrium, in closed form, both in and out of steady state. Using this characterization, we derive several novel implications that highlight the importance of heterogeneity. In particular, we show how some investors endogenously emerge as intermediaries, even though they have no advantage in contacting other agents or holding inventory; and we show how heterogeneity magnifies the impact of search frictions on asset prices, misallocation, and welfare.
Supersedes Working Paper 15-22.
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19-43: Relationship Networks in Banking Around a Sovereign Default and Currency Crisis by Pablo D’Erasmo, Hernán Moscoso Boedo, María Pía Olivero, and Máximo Sangiacomo

We study how banks’ exposure to a sovereign crisis gets transmitted onto the corporate sector. To do so we use data on the universe of banks and firms in Argentina during the crisis of 2001. We build a model characterized by matching frictions in which firms establish (long-term) relationships with banks that are subject to balance sheet disruptions. Credit relationships with banks more exposed to the crisis suffer the most. However, this relationship-level effect overstates the true cost of the crisis since profitable firms (e.g., exporters after a devaluation) might find it optimal to switch lenders, reducing the negative impact on overall credit and activity. Using linked bank-firm and firm-level data we find evidence largely consistent with our theory.
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19-42: Localized Knowledge Spillovers: Evidence from the Spatial Clustering of R&D Labs and Patent Citations by Kristy Buzard, Gerald A. Carlino, Robert M. Hunt, Jake K. Carr, and Tony E. Smith

Buzard et al. (2017) show that American R&D labs are highly spatially concentrated even within a given metropolitan area. We argue that the geography of their clusters is better suited for studying knowledge spillovers than are states, metropolitan areas, or other political or administrative boundaries that have predominantly been used in previous studies. In this paper, we assign patents and citations to these newly defined clusters of R&D labs. Our tests show that the localization of knowledge spillovers, as measured via patent citations, is strongest at small spatial scales and diminishes with distance. On average, patents within a cluster are about two to four times more likely to cite an inventor in the same cluster than one in a control group. Of import, we find that the degree of localization of knowledge spillovers will be understated in samples based on metropolitan area definitions compared to samples based on the R&D clusters. At the same time, the strength of knowledge spillovers varies widely between clusters. The results are robust to the specification of patent technological categories, the method of citation matching, and alternate cluster definitions.
Supersedes Working Paper 17-32.
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19-41: Concentration of Control Rights in Leveraged Loan Syndicates by Mitchell Berlin, Greg Nini, and Edison G. Yu

We find that corporate loan contracts frequently concentrate control rights with a subset of lenders. Despite the rise in term loans without financial covenants—so-called covenant-lite loans—borrowing firms' revolving lines of credit almost always retain traditional financial covenants. This split structure gives revolving lenders the exclusive right and ability to monitor and to renegotiate the financial covenants, and we confirm that loans with split control rights are still subject to the discipline of financial covenants. We provide evidence that split control rights are designed to mitigate bargaining frictions that have arisen with the entry of nonbank lenders and became apparent during the financial crisis.
Supersedes Working Paper 17-22.
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19-40: Policy Inertia, Election Uncertainty and Incumbency Disadvantage of Political Parties by Satyajit Chatterjee and Burcu Eyigungor

We document that postwar U.S. elections show a strong pattern of “incumbency disadvantage": If a party has held the presidency of the country or the governorship of a state for some time, that party tends to lose popularity in the subsequent election. We show that this fact can be explained by a combination of policy inertia and unpredictability in election outcomes. A quantitative analysis shows that the observed magnitude of incumbency disadvantage can arise in several different models of policy inertia. Normative and positive implications of policy inertia leading to incumbency disadvantage are explored.
Supersedes Working Papers 19-07, 17-43, and 16-36.
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19-39: The Mortgage Prepayment Decision: Are There Other Motivations Beyond Refinance and Move? by Arden Hall and Raman Quinn Maingi

Borrowers terminate residential mortgages for a variety of reasons. Prepayments and defaults have always been distinguishable, and researchers have recently distinguished between prepayments involving a move and other prepayments. But these categories still combine distinct decisions. For example, a borrower may refinance to obtain a lower interest rate or to borrow a larger amount. By matching mortgage servicing and credit bureau records, we are able to distinguish among several motivations for prepayment: simple refinancing, cash-out refinancing, mortgage payoff, and move. Using multinomial logit to estimate a competing hazard model for these types of prepayments plus default, we demonstrate that these outcomes are distinct, with some outcomes showing quite different relationships to standard predictive variables, such as refinance incentive, credit score, and loan-to-value ratio, than in models that combine outcomes. The implication of these findings is that models that aggregate prepayment types do not adequately describe borrower motivations.
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19-38: Competition and Health-Care Spending: Theory and Application to Certificate of Need Laws by James Bailey and Tom Hamami

Hospitals and other health-care providers in 34 states must obtain a Certificate of Need (CON) from a state board before opening or expanding, leading to reduced competition. We develop a theoretical model of how market concentration aspects health-care spending. Our theoretical model shows that increases in concentration, such as those brought about by CON, can either increase or decrease spending. Our model predicts that CON is more likely to increase spending in markets in which costs are low and patients are sicker. We test our model using spending data from the Household Component of the Medical Expenditure Panel Survey (MEPS).
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19-37: How Wide Is the Firm Border? by Enghin Atalay, Ali Hortaçsu, Mary Jialin Li, and Chad Syverson

We examine the within- and across-firm shipment decisions of tens of thousands of goods-producing and goods-distributing establishments. This allows us to quantify the normally unobservable forces that determine firm boundaries; that is, which transactions are mediated by ownership control, as opposed to contracts or markets. We find firm boundaries to be an economically significant barrier to trade: Having an additional vertically integrated establishment in a given destination ZIP code has the same effect on shipment volumes as a 40 percent reduction in distance. These effects are larger for high value-to-weight products, for faraway destinations, for differentiated products, and for IT-intensive industries.
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19-36: The Community Reinvestment Act (CRA) and Bank Branching Patterns by Lei Ding and Carolina K. Reid

This paper examines the relationship between the Community Reinvestment Act (CRA) and bank branching patterns, measured by the risk of branch closure and the net loss of branches at the neighborhood level, in the aftermath of Great Recession. Between 2009 and 2017, there was a larger decline in the number of bank branches in lower-income neighborhoods than in more affluent ones, raising concerns about access to mainstream financial services. However, once we control for supply and demand factors that influence bank branching decisions, we find generally consistent evidence that the CRA is associated with a lower risk of branch closure, and the effects are stronger for neighborhoods with fewer branches, for larger banks, and for major metro areas. The CRA also reduces the risk of net bank losses in lower-income neighborhoods. The evidence from our analysis is consistent with the notion that the CRA helps banks meet the credit needs of underserved communities and populations by ensuring the continued presence of brick-and-mortar branches.
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19-35: Formative Experiences and the Price of Gasoline by Christopher Severen and Arthur A. van Benthem

An individual’s initial experiences with a common good, such as gasoline, can shape their behavior for decades. We first show that the 1979 oil crisis had a persistent negative effect on the likelihood that individuals that came of driving age during this time drove to work in the year 2000 (i.e., in their mid 30s). The effect is stronger for those with lower incomes and those in cities. Combining data on many cohorts, we then show that large increases in gasoline prices between the ages of 15 and 18 significantly reduce both (i) the likelihood of driving a private automobile to work and (ii) total annual vehicle miles traveled later in life, while also increasing public transit use. Differences in driver license age requirements generate additional variation in the formative window. These effects cannot be explained by contemporaneous income and do not appear to be only due to increased costs from delayed driving skill acquisition. Instead, they seem to reflect the formation of preferences for driving or persistent changes in the perceived costs of driving.
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19-34: Cyclical Labor Income Risk by Makoto Nakajima and Vladimir Smirnyagin

We investigate cyclicality of variance and skewness of household labor income risk using PSID data. There are five main findings. First, we find that head’s labor income exhibits countercyclical variance and procyclical skewness. Second, the cyclicality of hourly wages is muted, suggesting that head’s labor income risk is mainly coming from the volatility of hours. Third, younger households face stronger cyclicality of income volatility than older ones, although the level of volatility is lower for the younger ones. Fourth, while a second earner helps lower the level of skewness, it does not mitigate the volatility of household labor income risk. Meanwhile, government taxes and transfers are found to mitigate the level and cyclicality of labor income risk volatility. Finally, among heads with strong labor market attachment, the cyclicality of labor income volatility becomes weaker, while the cyclicality of skewness remains.
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19-33: The Well-Being of Nations: Estimating Welfare from International Migration by Sanghoon Lee, Seung Hoon Lee, and Jeffrey Lin

The limitations of GDP as a measure of welfare are well known. We propose a new method of estimating the well-being of nations. Using gross bilateral international migration flows and a discrete choice model in which everyone in the world chooses a country in which to live, we estimate each country’s overall quality of life. Our estimates, by relying on revealed preference, complement previous estimates of economic well-being that consider only income or a small number of factors, or rely on structural assumptions about how these factors contribute to well-being.
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19-32: The Consequences of Student Loan Credit Expansions: Evidence from Three Decades of Default Cycles by Adam Looney and Constantine Yannelis

This paper studies the link between credit availability and student loan repayment using administrative federal student loan data. We demonstrate that expansions and contractions in federal student loan credit to institutions with high default rates explain most of the time series variation in student loan defaults between 1980 and 2010. Expansions in loan eligibility between 1976 and 1988 led to the entry of new, high-risk institutions, and default rates exceeding 30 percent in the late 1980s. Credit access was subsequently tightened through strict institutional and student accountability measures. This contracted credit availability at the highest default rate institutions, which in turn caused an exodus of institutions with high default rates, resulting in lower default rates on student loans. After 1992, the cycle was repeated, with credit access gradually loosened by unwinding many of the pre-1992 reforms. We confirm this time series narrative by examining discrete policy changes governing access to credit to show that tightening credit supply led to the closure of high-default schools and the relaxation of accountability rules resulted in their expansion. Our estimates imply that 85 percent of the increase in default between 1980 and 1990, and 95 percent of the decrease in default between 1990 and 2000 is driven by schools entering and exiting loan programs. One-third of the recent increase in default is associated with the entry of online programs following the relaxation of rules for lending to online schools, and another third is associated with the abolition of rules limiting the share of revenue coming from federal programs.
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19-31: History Remembered: Optimal Sovereign Default on Domestic and External Debt by Pablo D’Erasmo and Enrique G. Mendoza

Infrequent but turbulent overt sovereign defaults on domestic creditors are a “forgotten history” in macroeconomics. We propose a heterogeneous-agents model in which the government chooses optimal debt and default on domestic and foreign creditors by balancing distributional incentives versus the social value of debt for self-insurance, liquidity, and risk-sharing. A rich feedback mechanism links debt issuance, the distribution of debt holdings, the default decision, and risk premia. Calibrated to Eurozone data, the model is consistent with key long-run and debt-crisis statistics. Defaults are rare (1.2 percent frequency) and preceded by surging debt and spreads. Debt sells at the risk-free price most of the time, but the government’s lack of commitment reduces sustainable debt sharply.
Supersedes Working Paper 17-04.
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19-30: The Effects of Gentrification on the Well-Being and Opportunity of Original Resident Adults and Children by Quentin Brummet and Davin Reed

We use new longitudinal census microdata to provide the first causal evidence of how gentrification affects a broad set of outcomes for original resident adults and children. Gentrification modestly increases out-migration, though movers are not made observably worse off and neighborhood change is driven primarily by changes to in-migration. At the same time, many original resident adults stay and benefit from declining poverty exposure and rising house values. Children benefit from increased exposure to higher-opportunity neighborhoods, and some are more likely to attend and complete college. Our results suggest that accommodative policies, such as increasing the supply of housing in high-demand urban areas, could increase the opportunity benefits we find, reduce out-migration pressure, and promote long-term affordability.
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19-29: Freeway Revolts! by Jeffrey Brinkman and Jeffrey Lin

Freeway revolts were widespread protests across the U.S. following early urban Interstate construction in the mid-1950s. We present theory and evidence from panel data on neighborhoods and travel behavior to show that diminished quality of life from freeway disamenities inspired the revolts, affected the allocation of freeways within cities, and changed city structure. First, actual freeway construction diverged from initial plans in the wake of the growing freeway revolts and subsequent policy responses, especially in central neighborhoods. Second, freeways caused slower growth in population, income, and land values in central areas, but faster growth in outlying areas. These patterns suggest that in central areas, freeway disamenity effects exceeded small access benefits. Third, in a quantitative general equilibrium spatial model, the aggregate benefits from burying or capping freeways are large and concentrated downtown. This result suggests that targeted mitigation policies could improve welfare and helps explain why opposition to freeways is often observed in central neighborhoods. Disamenities from freeways, versus their commuting benefits, likely played a significant role in the decentralization of U.S. cities.
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19-28: Do Minimum Wage Increases Benefit Intended Households? Evidence from the Performance of Residential Leases by Sumit Agarwal, Brent W. Ambrose, and Moussa Diop

Prior studies debating the effects of changes to the minimum wage concentrate on impacts on household income and spending or employment. We extend this debate by examining the impact of changes to the minimum wage on expenses associated with shelter, a previously unexplored area. Increases in state minimum wages significantly reduce the incidence of renters defaulting on their lease contracts by 1.29 percentage points over three months, relative to similar renters who did not experience an increase in the minimum wage. This represents 25.7% fewer defaults post treatment in treated states. To put this into perspective, a 1% increase in minimum wage translates into a 2.6% decrease in rental default. This evidence is consistent with wage increases having an immediate impact on relaxing renter budget constraints. However, this effect slowly decreases over time as landlords react to wage increases by increasing rents. Our analysis is based on a unique data set that tracks household rental payments.
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19-27: Pre-event Trends in the Panel Event-Study Design by Simon Freyaldenhoven, Christian Hansen, and Jesse M. Shapiro

We consider a linear panel event-study design in which unobserved confounds may be related both to the outcome and to the policy variable of interest. We provide sufficient conditions to identify the causal effect of the policy by exploiting covariates related to the policy only through the confounds. Our model implies a set of moment equations that are linear in parameters. The effect of the policy can be estimated by 2SLS, and causal inference is valid even when endogeneity leads to pre-event trends ("pre-trends") in the outcome. Alternative approaches perform poorly in our simulations.
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19-26: Should Central Banks Issue Digital Currency? by Todd Keister and Daniel Sanches

We study how the introduction of a central bank-issued digital currency affects interest rates, the level of economic activity, and welfare in an environment where both central bank money and private bank deposits are used in exchange. Banks in our model are financially constrained, and the liquidity premium on bank deposits affects the level of aggregate investment. We study the optimal design of a digital currency in this setting, including whether it should pay interest and how widely it should circulate. We highlight an important policy tradeoff: while a digital currency tends to promote efficiency in exchange, it can also crowd out bank deposits, raise banks' funding costs, and decrease investment. Despite these effects, introducing a central bank digital currency often raises welfare.

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19-25: Financial Characteristics of Cost of Funds Indexed Loans by Patrick Greenfield and Arden Hall

Two recent articles by Hancock and Passmore (2016) and Passmore and von Hafften (2017) make several suggestions for improving the home mortgage contract to make homeownership more achievable for creditworthy borrowers. Though the proposals in the two papers differ in some aspects, one common feature is an adjustable rate indexed to a cost of funds (COF) measure. Such indices are based on the interest expense as a fraction of liability balance for one or a group of depository institutions. One of these, the 11th District Cost of Funds (COF) Index, was in wide use in the 1980s and ’90s, but use has fallen off since then. COF indices have the advantage that they are less volatile than market-based indices such as the 1-year U.S. Treasury rate, so that borrowers are not exposed to rapid increases in payments in a rising rate environment. We analyze COF-indexed ARMs from the point of view of the lender. First we develop a methodology for constructing a liability portfolio that closely tracks the specific COF index proposed by Hancock and Passmore (2016) and Passmore and von Hafften (2017). We then explore the financial characteristics of this liability portfolio. We show that the liability portfolio, and by implication, the mortgages it would fund, share a characteristic of fixed-rate mortgages: Values can vary significantly from par if rates change. This creates two problems for lenders: Pricing of COF-indexed ARMs is difficult because it depends not only on current interest rates but also on interest rates when principal is repaid, either through amortization or prepayment. Second, deviations from par make mortgage prepayment options valuable, so that lenders offering the product must manage option risk as well as interest rate risk. We conclude that while mortgages using a COF index have clear benefits for borrowers, they also are more difficult for lenders to price accurately. Further, once they are in lenders’ portfolios, they increase the complexity of interest rate risk management. While these issues do not imply that COF indices cannot be part of innovative new mortgage designs, understanding their financial characteristics may contribute to the search for a better mortgage.
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19-24: Institution, Major, and Firm-Specific Premia: Evidence from Administrative Data by Ben Ost, Weixiang Pan, and Douglas Webber

We examine how a student’s major and the institution attended contribute to the labor market outcomes of young graduates. Administrative panel data that combine student transcripts with matched employer-employee records allow us to provide the first decomposition of premia into individual and firm-specific components. We find that both major and institutional premia are more strongly related to the firm-specific component of wages than the individual-specific component of wages. On average, a student’s major is a more important predictor of future wages than the selectivity of the institution attended, but major premia (and their relative ranking) can differ substantially across institutions, suggesting the importance of program-level data for prospective students and their parents.
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19-23: A Generalized Factor Model with Local Factors by Simon Freyaldenhoven

I extend the theory on factor models by incorporating local factors into the model. Local factors only affect an unknown subset of the observed variables. This implies a continuum of eigenvalues of the covariance matrix, as is commonly observed in applications. I derive which factors are pervasive enough to be economically important and which factors are pervasive enough to be estimable using the common principal component estimator. I then introduce a new class of estimators to determine the number of those relevant factors. Unlike existing estimators, my estimators use not only the eigenvalues of the covariance matrix, but also its eigenvectors. I find strong evidence of local factors in a large panel of US macroeconomic indicators.
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19-22: Consumer Lending Efficiency: Commercial Banks versus a Fintech Lender by Joseph P. Hughes, Julapa Jagtiani, and Choon-Geol Moon

We compare the performance of unsecured personal installment loans made by traditional bank lenders with that of LendingClub, using a stochastic frontier estimation technique to decompose the observed nonperforming loans into three components. The first is the best-practice minimum ratio that a lender could achieve if it were fully efficient at credit-risk evaluation and loan management. The second is a ratio that reflects the difference between the observed ratio (adjusted for noise) and the minimum ratio that gauges the lender’s relative proficiency at credit analysis and loan monitoring. The third is statistical noise. In 2013 and 2016, the largest bank lenders experienced the highest ratio of nonperformance, the highest inherent credit risk, and the highest lending efficiency, indicating that their high ratio of nonperformance is driven by inherent credit risk, rather than by lending inefficiency. LendingClub’s performance was similar to small bank lenders as of 2013. As of 2016, LendingClub’s performance resembled the largest bank lenders — the highest ratio of nonperforming loans, inherent credit risk, and lending efficiency — although its loan volume was smaller. Our findings are consistent with a previous study that suggests LendingClub became more effective in risk identification and pricing starting in 2015. Caveat: We note that this conclusion may not be applicable to fintech lenders in general, and the results may not hold under different economic conditions such as a downturn.
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19-21: Demographic Aging, Industrial Policy, and Chinese Economic Growth by Michael Dotsey, Wenli Li, and Fang Yang

Superseded by Working Paper 19-55.
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19-20: Capitalization as a Two-Part Tariff: The Role of Zoning by H. Spencer Banzhaf and Kyle Mangum

This paper shows that the capitalization of local amenities is effectively priced into land via a two-part pricing formula: a “ticket” price paid regardless of the amount of housing service consumed and a “slope” price paid per unit of services. We first show theoretically how tickets arise as an extensive margin price when there are binding constraints on the number of households admitted to a neighborhood. We use a large national dataset of housing transactions, property characteristics, and neighborhood attributes to measure the extent to which local amenities are capitalized in ticket prices vis-à-vis slopes. We find that in most U.S. cities, the majority of neighborhood variation in pricing occurs via tickets, although the importance of tickets rises sharply in the stringency of land development regulations, as predicted by theory. We discuss implications of two-part pricing for efficiency and equity in neighborhood sorting equilibria and for empirical estimates of willingness to pay for non marketed amenities, which generally assume proportional pricing only.
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19-19: Mortgage Loss Severities: What Keeps Them So High? by Xudong An and Larry Cordell

Mortgage loss-given-default (LGD) increased significantly when house prices plummeted and delinquencies rose during the financial crisis, but it has remained over 40 percent in recent years despite a strong housing recovery. Our results indicate that the sustained high LGDs post-crisis are due to a combination of an overhang of crisis-era foreclosures and prolonged foreclosure timelines, which have offset higher sales recoveries. Simulations show that cutting foreclosure timelines by one year would cause LGD to decrease by 5–8 percentage points, depending on the trade-off between lower liquidation expenses and lower sales recoveries. Using difference-in-differences tests, we also find that recent consumer protection programs have extended foreclosure timelines and increased loss severities in spite of their benefits of increasing loan modifications and enhancing consumer protections.
Supersedes Working Paper 17-08.
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19-18: The Firm Size and Leverage Relationship and Its Implications for Entry and Concentration in a Low Interest Rate World by Satyajit Chatterjee and Burcu Eyigungor

Larger firms (by sales or employment) have higher leverage. This pattern is explained using a model in which firms produce multiple varieties and borrow with the option to default against their future cash flow. A variety can die with a constant probability, implying that bigger firms (those with more varieties) have lower coefficient of variation of sales and higher leverage. A lower risk-free rate benefits bigger firms more as they are able to lever more and existing firms buy more of the new varieties arriving into the economy. This leads to lower startup rates and greater concentration of sales.
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19-17: Building Credit History with Heterogeneously Informed Lenders by Natalia Kovrijnykh, Igor Livshits, and Ariel Zetlin-Jones

This paper examines a novel mechanism of credit-history building as a way of aggregating information across multiple lenders. We build a dynamic model with multiple competing lenders, who have heterogeneous private information about a consumer's creditworthiness, and extend credit over multiple stages. Acquiring a loan at an early stage serves as a positive signal | it allows the borrower to convey to other lenders the existence of a positively informed lender (advancing that early loan) — thereby convincing other lenders to extend further credit in future stages. This signaling may be costly to the least risky borrowers for two reasons. First, taking on an early loan may involve cross-subsidization from the least risky borrowers to more risky borrowers. Second, the least risky borrowers may take inefficiently large loans relative to the symmetric-information benchmark. We demonstrate that, despite these two possible costs, the least risky borrowers often prefer these equilibria to those without information aggregation. Our analysis offers an interesting and novel insight into debt dilution. Contrary to the conventional wisdom, repayment of the early loan is more likely when a borrower subsequently takes on a larger rather than a smaller additional loan. This result hinges on a selection effect: larger subsequent loans are only given to the least risky borrowers.
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19-16: Beautiful City: Leisure Amenities and Urban Growth by Gerald A. Carlino and Albert Saiz

Modern urban economic theory and policymakers are coming to see the provision of consumer-leisure amenities as a way to attract population, especially the highly skilled and their employers. However, past studies have arguably only provided indirect evidence of the importance of leisure amenities for urban development. In this paper, we propose and validate the number of tourist trips and the number of crowdsourced picturesque locations as measures of consumer revealed preferences for local lifestyle amenities. Urban population growth in the 1990-2010 period was about 10 percentage points (about one standard deviation) higher in a metro area that was perceived as twice more picturesque. This measure ties with low taxes as the most important predictor of urban population growth. “Beautiful cities” disproportionally attracted highly educated individuals and experienced faster housing price appreciation, especially in supply-inelastic markets. In contrast to the generally declining trend of the American central city, neighborhoods that were close to central recreational districts have experienced economic growth, albeit at the cost of minority displacement.
Supersedes Working Paper 08-22.
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19-15: Banking Regulation with Risk of Sovereign Default by Pablo D’Erasmo, Igor Livshits, and Koen Schoors

Banking regulation routinely designates some assets as safe and thus does not require banks to hold any additional capital to protect against losses from these assets. A typical such safe asset is domestic government debt. There are numerous examples of banking regulation treating domestic government bonds as “safe,” even when there is clear risk of default on these bonds. We show, in a parsimonious model, that this failure to recognize the riskiness of government debt allows (and induces) domestic banks to “gamble” with depositors’ funds by purchasing risky government bonds (and assets closely correlated with them). A sovereign default in this environment then results in a banking crisis. Critically, we show that permitting banks to gamble this way lowers the cost of borrowing for the government. Thus, if the borrower and the regulator are the same entity (the government), that entity has an incentive to ignore the riskiness of the sovereign bonds. We present empirical evidence in support of the key mechanism we are highlighting, drawing on the experience of Russia in the run-up to its 1998 default and on the recent Eurozone debt crisis.
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19-14: We Are All Behavioral, More or Less: Measuring and Using Consumer-Level Behavioral Sufficient Statistics by Victor Stango and Jonathan Zinman

Can a behavioral sufficient statistic empirically capture cross-consumer variation in behavioral tendencies and help identify whether behavioral biases, taken together, are linked to material consumer welfare losses? Our answer is yes. We construct simple consumer-level behavioral sufficient statistics — “B-counts” — by eliciting seventeen potential sources of behavioral biases per person, in a nationally representative panel, in two separate rounds nearly three years apart. B-counts aggregate information on behavioral biases within-person. Nearly all consumers exhibit multiple biases, in patterns assumed by behavioral sufficient statistic models (a la Chetty), and with substantial variation across people. B-counts are stable within-consumer over time, and that stability helps to address measurement error when using B-counts to model the relationship between biases, decision utility, and experienced utility. Conditional on classical inputs — risk aversion and patience, life-cycle factors and other demographics, cognitive and non-cognitive skills, and financial resources — B-counts strongly negatively correlate with both objective and subjective aspects of experienced utility. The results hold in much lower-dimensional models employing “Sparsity B-counts” based on bias subsets (a la Gabaix) and/or fewer covariates, illuminating lower-cost ways to use behavioral sufficient statistics to help capture the combined influence of multiple behavioral biases for a wide range of research questions and applications.
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19-13: A Shortage of Short Sales: Explaining the Underutilization of a Foreclosure Alternative by Calvin Zhang

The Great Recession led to widespread mortgage defaults, with borrowers resorting to both foreclosures and short sales to resolve their defaults. I first quantify the economic impact of foreclosures relative to short sales by comparing the home price implications of both. After accounting for omitted variable bias, I find that homes selling as short sales transact at 9.2% to 10.5% higher prices on average than those that sell after foreclosure. Short sales also exert smaller negative externalities than foreclosures, with one short sale decreasing nearby property values by 1 percentage point less than a foreclosure. So why weren’t short sales more prevalent? These home price benefits did not increase the prevalence of short sales because free rents during foreclosures caused more borrowers to select foreclosures, even though higher advances led servicers to prefer more short sales. In states with longer foreclosure timelines, the benefits from foreclosures increased for borrowers, so short sales were less utilized. I find that one standard deviation increase in the average length of the foreclosure process decreased the short sale share by 0.35 to 0.45 standard deviation. My results suggest that policies that increase the relative attractiveness of short sales could help stabilize distressed housing markets.
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19-12 Revised: A Dynamic Model of Intermediated Consumer Credit and Liquidity by Pedro Gomis-Porqueras and Daniel Sanches

We construct a tractable model of consumer credit with settlement frictions (i.e., a consumer credit market that relies on a secondary market for privately issued debt claims to operate) to study the role of monetary policy in the efficient functioning of the payments system. In our framework, intermediaries hold reserves across periods to take advantage of rediscounting opportunities, and monetary policy influences the equilibrium allocation through the interest rate on reserves. We characterize the conditions for the existence of an allocation in which privately issued debt claims are not discounted in equilibrium. We also discuss the role of monetary policy in the payments system across different market structures in the intermediary sector and characterize the minimum size of the intermediary sector required to attain efficiency.
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19-11: Toward a Framework for Time Use, Welfare, and Household-Centric Economic Measurement by Diane Coyle and Leonard Nakamura

What is meant by economic progress, and how should it be measured? The conventional answer is growth in real GDP over time or compared across countries, a monetary measure adjusted for the general rate of increase in prices. However, there is increasing interest in developing an alternative understanding of economic progress, particularly in the context of digitalization of the economy and the consequent significant changes Internet use is bringing about in production and household activity. This paper discusses one alternative approach, combining an extended utility framework considering time allocation over paid work, household work, leisure, and consumption with measures of objective or subjective well-being while engaging in different activities. Developing this wider economic welfare measure would require the collection of time use statistics as well as well-being data and direct survey evidence, such as the willingness to pay for leisure time. We advocate an experimental set of time and well-being accounts, with a particular focus on the digitally driven shifts in behavior.
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19-10: Frictional Intermediation in Over-the-Counter Markets by Julien Hugonnier, Benjamin Lester, and Pierre-Olivier Weill

We extend Duffie, Gârleanu, and Pedersen’s (2005) search-theoretic model of over-the-counter (OTC) asset markets, allowing for a decentralized inter-dealer market with arbitrary heterogeneity in dealers’ valuations or inventory costs. We develop a solution technique that makes the model fully tractable and allows us to derive, in closed form, theoretical formulas for key statistics analyzed in empirical studies of the intermediation process in OTC markets. A calibration to the market for municipal securities reveals that the model can generate trading patterns and prices that are quantitatively consistent with the data. We use the calibrated model to compare the gains from trade that are realized in this frictional market with those from a hypothetical, frictionless environment, and to distinguish between the quantitative implications of various types of heterogeneity across dealers.
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19-09: Investigating Nonneutrality in a State-Dependent Pricing Model with Firm-Level Productivity Shocks by Michael Dotsey and Alexander L. Wolman

In recent years, there has been an abundance of empirical work examining price setting behavior at the micro level. First generation models with price setting rigidities were generally at odds with much of the micro price data. A second generation of models, with fixed costs of price adjustment and idiosyncratic shocks, have attempted to rectify this shortcoming. Using a model that matches a large set of microeconomic facts we find significant nonneutrality. We decompose the nonneutrality and find that state dependence plays an important part in the responses of output and inflation to a monetary shock. We also examine how aggregating firm behavior can generate flat hazards. Last, we find that the steady state statistic developed by Alvarez, Le Bihan, and Lippi (2016) is an imperfect guide to characterizing nonneutrality in our model.
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19-08: From Incurred Loss to Current Expected Credit Loss (CECL): A Forensic Analysis of the Allowance for Loan Losses in Unconditionally Cancelable Credit Card Portfolios by José J. Canals-Cerdá

Superseded by Working Paper 20-09.
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19-07: Incumbency Disadvantage of Political Parties: The Role of Policy Inertia and Prospective Voting by Satyajit Chatterjee and Burcu Eyigungor

Superseded by Working Paper 19-40.
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19-06: How Big Is the Wealth Effect? Decomposing the Response of Consumption to House Prices by S. Borağan Aruoba, Ronel Elul, and Şebnem Kalemli-Özcan

We investigate the effect of declining house prices on household consumption behavior during 2006–2009. We use an individual-level dataset that has detailed information on borrower characteristics, mortgages and credit risk. Proxying consumption by individual-level auto loan originations, we decompose the effect of declining house prices on consumption into three main channels: wealth effect, household financial constraints, and bank health. We find a negligible wealth effect. Tightening household-level financial constraints can explain 40-45 percent of the response of consumption to declining house prices. Deteriorating bank health leads to reduced credit supply both to households and firms. Our dataset allows us to estimate the effect of this on households as 20-25 percent of the consumption response. The remaining 35 percent is a general equilibrium effect that works via a decline in employment as a result of either lower credit supply to firms or the feedback from lower consumer demand. Our estimate of a negligible wealth effect is robust to accounting for the endogeneity of house prices and unemployment. The contribution of tightening household financial constraints goes down to 35 percent, whereas declining bank credit supply to households captures about half of the overall consumption response, once we account for endogeneity.
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19-05: Firm Wages in a Frictional Labor Market by Leena Rudanko

This paper studies a labor market with directed search, where multi-worker firms follow a firm wage policy: They pay equally productive workers the same. The policy reduces wages, due to the influence of firms’ existing workers on their wage setting problem, increasing the profitability of hiring. It also introduces a time-inconsistency into the dynamic firm problem, because firms face a less elastic labor supply in the short run. To consider outcomes when firms reoptimize each period, I study Markov perfect equilibria, proposing a tractable solution approach based on standard Euler equations. In two applications, I first show that firm wages dampen wage variation over the business cycle, amplifying that in unemployment, with quantitatively significant effects. Second, I show that firm wage firms may find it profitable to fix wages for a period of time, and that an equilibrium with fixed wages can be good for worker welfare, despite added volatility in the labor market.
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19-04: Bank Size and Household Financial Sentiment: Surprising Evidence from the University of Michigan Surveys of Consumers by Allen N. Berger, Felix Irresberger, and Raluca A. Roman

We analyze comparative advantages/disadvantages of small and large banks in improving household sentiment regarding financial conditions. We match sentiment data from the University of Michigan Surveys of Consumers with local banking market data from 2000 to 2014. Surprisingly, the evidence suggests that large rather than small banks have significant comparative advantages in boosting household sentiment. Findings are robust to instrumental variables and other econometric methods. Additional analyses are consistent with both scale economies and the superior safety of large banks as channels behind the main findings. These channels appear to more than offset stronger relationships with and greater trust in small banks.
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19-03: Elasticities of Labor Supply and Labor Force Participation Flows by Isabel Cairó, Shigeru Fujita, and Camilo Morales-Jiménez

Superseded by Working Paper 20-23.
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19-02: Financial Consequences of Identity Theft: Evidence from Consumer Credit Bureau Records by Nathan Blascak, Julia Cheney, Robert Hunt, Vyacheslav Mikhed, Dubravka Ritter, and Michael Vogan

This paper examines how a negative shock to the security of personal finances due to severe identity theft changes consumer credit behavior. Using a unique data set of consumer credit records and alerts indicating identity theft and the exogenous timing of victimization, we show that the immediate effects of fraud on credit files are typically negative, small, and transitory. After those immediate effects fade, identity theft victims experience persistent, positive changes in credit characteristics, including improved Risk Scores. Consumers also exhibit caution with credit by having fewer open revolving accounts while maintaining total balances and credit limits. Our results are consistent with consumer inattention to credit reports prior to identity theft and reduced trust in credit card markets after identity theft.
Supersedes Working Paper 16-27.
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19-01: Leaving Households Behind: Institutional Investors and the U.S. Housing Recovery by Lauren Lambie-Hanson, Wenli Li, and Michael Slonkosky

Superseded by Working Paper 19-45.
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