31-40 of 362 Results

Article

Estimation Error in Optimal Portfolio Allocation Problems  

Jose Olmo

Markowitz showed that an investor who cares only about the mean and variance of portfolio returns should hold a portfolio on the efficient frontier. The application of this investment strategy proceeds in two steps. First, the statistical moments of asset returns are estimated from historical time series, and second, the mean-variance portfolio selection problem is solved separately, as if the estimates were the true parameters. The literature on portfolio decision acknowledges the difficulty in estimating means and covariances in many instances. This is particularly the case in high-dimensional settings. Merton notes that it is more difficult to estimate means than covariances and that errors in estimates of means have a larger impact on portfolio weights than errors in covariance estimates. Recent developments in high-dimensional settings have stressed the importance of correcting the estimation error of traditional sample covariance estimators for portfolio allocation. The literature has proposed shrinkage estimators of the sample covariance matrix and regularization methods founded on the principle of sparsity. Both methodologies are nested in a more general framework that constructs optimal portfolios under constraints on different norms of the portfolio weights including short-sale restrictions. On the one hand, shrinkage methods use a target covariance matrix and trade off bias and variance between the standard sample covariance matrix and the target. More prominence has been given to low-dimensional factor models that incorporate theoretical insights from asset pricing models. In these cases, one has to trade off estimation risk for model risk. Alternatively, the literature on regularization of the sample covariance matrix uses different penalty functions for reducing the number of parameters to be estimated. Recent methods extend the idea of regularization to a conditional setting based on factor models, which increase with the number of assets, and apply regularization methods to the residual covariance matrix.

Article

The History of Central Banks  

Eric Monnet

The historical evolution of the role of central banks has been shaped by two major characteristics of these institutions: they are banks and they are linked—in various legal, administrative, and political ways—to the state. The history of central banking is thus an analysis of how central banks have ensured or failed to ensure the stability of the value of money and the credit system while maintaining supportive or conflicting relationships with governments and private banks. Opening the black box of central banks is necessary to understanding the political economy issues that emerge from the implementation of monetary and credit policy and why, in addition to macroeconomic effects, these policies have major consequences on the structure of financial systems and the financing of public debt. It is also important to read the history of the evolution of central banks since the end of the 19th century as a game of countries wanting to adopt a dominant institutional model. Each historical period was characterized by a dominant model that other countries imitated - or pretended to imitate while retaining substantial national characteristics - with a view to greater international political and financial integration. Recent academic research has explored several issues that underline the importance of central banks to the development of the state, the financial system and on macroeconomic fluctuations: (a) the origin of central banks; (b) their role as a lender of last resort and banking supervisor; (c) the justifications and consequences of domestic macroeconomic policy objectives - inflation, output, etc. -of central banks (monetary policy); (d) the special loans of central banks and their role in the allocation of credit (credit policy); (e) the legal and political links between the central bank and the government (independence); (f) the role of central banks concerning exchange rates and the international monetary system; (g) production of economic research and statistics.

Article

Housing and Macroeconomics  

Charles Ka Yui Leung

The earlier literature on macroeconomics focused on determining aggregate variables such as gross domestic product (GDP), inflation rate, and unemployment rate. It had little interaction with the literature on housing. The importance of housing in the macroeconomy has been recently discovered, and the macro-housing field is in development. The recent literature addresses several policy-relevant issues that are important for macroeconomics and housing strands of literature. One of the significant developments is the research on the rental market, as a considerable portion of the world population are renters. For instance, the impact of some macroeconomic policies depends on how easily a unit is converted between rental or owner-occupied housing. Just as failure to keep up with the mortgage payment in owner-occupied housing would lead to bankruptcy, failure to pay rent as the contract described could lead to eviction. The literature has started to investigate the causes and costs of such displacement. Some authors also explore whether public rental housing is a desirable policy. Another active research area is affordability. Some people could afford to rent but not own housing in some cities. Some may move to places where they can be house owners. The literature has started to explore such interactions of the locational choice with the tenure choice (i.e., to rent or to own). The durability of housing makes it a long-term investment. Hence, the timing and pricing of the current period housing transaction depend on the expectations of future prices. Moreover, the recent period transactions in the housing market could, in turn, affect future prices. Therefore, self-fulfilling prophecies are possible, and it is crucial to study the formation and evolution of expectations in the housing market. Some researchers have taken up the challenges and made some progress. Last but not least, the literature has extended from a single-market to a multi-market setting. Emerging literature studies the local housing and labor market, such as the county level, and brings results that challenge conventional wisdom. In response, a few authors have developed sophisticated multi-regional dynamic general equilibrium models to match the cross-sectional and time series facts and maintain the forward-looking assumption in the macroeconomics tradition. Those new models also help us to identify shocks that are not directly observable to econometricians and, at the same time, are essential to account for cross-sectional economic facts. They can bring us closer to the actual situation. In sum, the recent developments in macro-housing literature are exciting and encouraging. They would accompany scholars on the journey of evidence-based public policy formation.

Article

Leverage in Private Equity Real Estate  

Jacob S. Sagi and Zipei Zhu

Private equity real estate (PERE) refers to professionally managed pooled investments in the real estate market available only to institutions (e.g., pension funds), private accredited investors, and high-net-worth individuals. In the ownership structure of PERE funds, general partners (GPs) serve as the active fund managers who raise an extensive amount of external capital from limited partners (LPs) to acquire and operate commercial real estate properties. Debt financing, namely the use of leverage, is prevalent in real estate investments and even more so in the setting of PERE funds. Though much empirical research is devoted to PERE fund performance, few studies directly investigate the role of financial leverage in PERE funds. In an ideal friction-free setting, leverage creates no value and is essentially part of a zero-sum game of rights and privileges between various asset stakeholders. In practice, however, leverage seems far from irrelevant due to the existence of market frictions that could lead to value creation (or destruction) by its use. Financial economic theories indicate that leverage can amplify skill (or the lack thereof), reallocate cash flow rights, and shift incentives in the presence of market frictions. With PERE, existing work provides mixed or little evidence that leverage is employed to amplify skill and consistently hints that its use shifts the balance of benefits toward fund sponsors over their limited partners. Based on data from Preqin and StepStone, a typical closed-end PERE fund targets roughly 65% debt to the value of total assets under management. Funds managing more risky real estate tend to use more leverage, and there is little evidence that fund terms are adjusted to reflect potential conflicts of interest posed by more intensive use of leverage. Rather, stylized facts raise concerns that the scope for conflict of interest may have increased over the past 10 years. Among these concerns is an increase in strategic longer-term use of subscription facilities. The bulk of evidence in the literature points to robust underperformance of high-leverage funds on a net-of-fee risk-adjusted basis. In other words, there is little evidence supporting the notion that leverage is employed to enhance skilled management and to benefit LPs. This suggests that a significant portion of PERE investors are not optimizing risk-return tradeoffs in allocating investments to high-leverage PERE funds. More work is needed to refine these findings and, more importantly, understand the source of market frictions behind them.

Article

The Role of Incentives for Improving Students’ Motivation and Performance  

Andreas Fidjeland

Although the returns to education can be substantial, many students underperform in school, for example, by not putting in sufficient effort. To mitigate this underinvestment problem, policymakers are often eager to try to motivate students using extrinsic incentives, such as cash payments and merit scholarships, stricter grading standards, and more competitive admission processes. The design, scope, and implementation of such incentive policies with the goal of affecting student motivation and study habits have been a fruitful area of economic research over the last 30 years. However, the evidence on their potency for improving student performance is mixed. In particular, the use of extrinsic incentives often elicit strategic responses from students, resulting in behavior that might improve performance metrics, but are not productive in terms of learning and skill development. Many incentive policies have therefore ended up producing unintended consequences that goes contrary to the policy objective. As incentives are everywhere in any school system, economists should pursue a better understanding of how they affect which outcomes students focus on, the choices they make, and how these effects differ across groups of students. Broadening the scope of outcomes considered when assessing the effects of incentives, in particular a greater focus on what student’s choose not to do, could provide a fruitful foundation for future research.

Article

Trade Liberalization and Informal Labor Markets  

Lourenço S. Paz and Jennifer P. Poole

In recent decades, economic reforms and technological advances have profoundly altered the way employers do business—for instance, the nature of employment relationships, the skills firms demand, and the goods and services they produce and export. In many developing economies, these changes took place concurrently with a substantive rise in work outside of the formal economy. According to International Labour Organization estimates, informal employment can be as high as 88% of total employment in India, almost 50% in Brazil, and around 35% of employment in South Africa. Such informal employment is typically associated with lower wages, lower productivity, poorer working conditions, weaker employment protections, and fewer job benefits and amenities, and these informal workers are often poorer and more vulnerable than their counterparts in the formalized economy. Informal jobs are a consequence of labor market policies—like severance payments or social security contributions—that make the noncompliant informal job cheaper for the employer than a compliant formal job. Each model has a different benefit (or lack of punishment) for employing formal workers, and a distinct mechanism through which international trade shocks alter the benefit-cost of these types of jobs, which in turn results in a change in the informality share. The empirical literature concerning international trade and formality largely points to an unambiguous increase in informal employment in the aftermath of increased import competition. Interestingly, increased access to foreign markets, via liberalization of major trading partners, offers strongly positive implications for formal employment opportunities, decreasing informality. Such effects are moderated by the de facto enforcement of labor regulations. Expansions toward the formal economy and away from informal wage employment in the aftermath of increased access to foreign markets are smaller in strictly enforced areas of the country.

Article

Assessments in Education  

Hans Henrik Sievertsen

Assessments like standardized tests and teacher evaluations are central elements of educational systems. Assessments affect the behaviour of students, teachers, parents, schools, and policymakers through at least two channels: The information channel and the incentive channel. Students use the information to adjust study effort and to guide their course selection. Schools and teachers use information from assessments to evaluate teaching quality and the effectiveness of the applied methods. Educational programs use information from assessment results to sort students in educational programs and employers use the results as signals of productivity in their hiring decisions. Finally, policymakers use assessments in accountability systems to reward or penalize schools, and parents use information from assessment results to select schools. The incentive channel is a natural consequence of the information channel: Students are incentivized to work hard and do well in assessments to get access to educational programs and jobs. Teachers and schools are incentivized to do well to receive rewards or avoid punishments in accountability systems. The information channel is important for ensuring the most efficient human capital investments: students learn about the returns and costs of effort investments and about their abilities and comparative advantages. Teachers and schools learn about the most effective teaching methods. However, because of the strong incentives linked to assessments, both students and teachers might focus on optimizing assessment results at the cost of learning. Students might for example select tracks that maximize their grades instead of selecting tracks aligned with their interests and comparative advantages. Understanding the implications of assessments for the behaviour of students, parents, teachers, and schools is therefore necessary to achieve the overall goals of the educational system. Because education affects lifetime earnings, health, and well-being and assessments play an important role in individuals’ educational careers, assessments are also important for efficiency and equity across domains. Biases in assessments and the heterogeneity in access to assessments are sources of inequality in education according to gender, origin, and socioeconomic background. Finally, because assessment results also carry important consequences for individuals’ educational opportunities and in the labor market, they are a source of stress and reduced well-being.

Article

Forecasting Electricity Prices  

Katarzyna Maciejowska, Bartosz Uniejewski, and Rafal Weron

Forecasting electricity prices is a challenging task and an active area of research since the 1990s and the deregulation of the traditionally monopolistic and government-controlled power sectors. It is interdisciplinary by nature and requires expertise in econometrics, statistics or machine learning for developing well-performing predictive models, finance for understanding market mechanics, and electrical engineering for comprehension of the fundamentals driving electricity prices. Although electricity price forecasting aims at predicting both spot and forward prices, the vast majority of research is focused on short-term horizons which exhibit dynamics unlike in any other market. The reason is that power system stability calls for a constant balance between production and consumption, while being dependent on weather (in terms of demand and supply) and business activity (in terms of demand only). The recent market innovations do not help in this respect. The rapid expansion of intermittent renewable energy sources is not offset by the costly increase of electricity storage capacities and modernization of the grid infrastructure. On the methodological side, this leads to three visible trends in electricity price forecasting research. First, there is a slow but more noticeable tendency to consider not only point but also probabilistic (interval, density) or even path (also called ensemble) forecasts. Second, there is a clear shift from the relatively parsimonious econometric (or statistical) models toward more complex and harder to comprehend but more versatile and eventually more accurate statistical and machine learning approaches. Third, statistical error measures are regarded as only the first evaluation step. Since they may not necessarily reflect the economic value of reducing prediction errors, in recent publications they tend to be complemented by case studies comparing profits from scheduling or trading strategies based on price forecasts obtained from different models.

Article

Human Capital in a Historical Perspective  

Gabriele Cappelli, Leonardo Ridolfi, and Michelangelo Vasta

Human capital can be defined as the set of knowledge and skills that individuals accumulate over time. These range from basic competences to more sophisticated forms of knowledge (intermediate and upper-tail human capital). All of them entail complex measurement problems in historical perspective as sources are often too scarce, problematic, and unreliable to allow proper measurement. Human capital is usually measured relying on the extensive margin of education or the quantity of education, that is, how many people are able to read or count or how many people have a certain degree of schooling. Less is known about the effective acquisition of skills, for example, the quality of education. Human capital can affect labor productivity and innovative capacity and it is generally regarded as one of the most important determinants of economic growth, figuring prominently in debates on the origin of the Industrial Revolution and the transition from preindustrial to modern economic growth. The determinants of education are several and vary widely over time and across space, including economic, institutional, cultural, and social factors. Historically, the acquisition of skills has deeply changed in nature, passing from the largely decentralized and fragmented systems of the preindustrial period to the 19th-century systems of mass education, where education was more and more universal and free, and the accumulation of skills was largely coordinated by states and other public authorities. In several regards, literature on human capital is still limited. Few efforts, for instance, have been made to harmonize data, integrate them in a comparative and regional perspective, explore the potential of individual-level information, and assess if and to what extent different dimensions of human capital such as technical and higher education have affected long-term patterns in economic growth and development. Other aspects have long been neglected or remain virtually unexplored, such as gender differences in education, the efficiency of education systems and its determinants, and the analysis of human capital in developing countries.

Article

International Trade and Labor Markets  

Greg Wright

China's entry into the World Trade Organization in 2001 rapidly integrated tens of millions of low-skilled workers into the global labor market, establishing a new center for low-wage goods manufacturing and offering a distinct opportunity to test models of international trade. Recent literature has found that the impact of this “China shock” has been uneven across regions within countries. Theoretically, region-specific labor market outcomes emerge only when there are internal barriers to factor mobility within a country, suggesting these barriers were underestimated prior to the extensive empirical research sparked by the China shock. Since workers with limited formal education and those outside the 25-39 age range are considerably less mobile than others, these workers have experienced more negative outcomes due to exposure to import competition in recent decades. Most notably, these workers have suffered the bulk of workforce displacement and attendant social ills resulting from China's rise as a global economic power.