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Article

The house price boom that has been present in most Chinese cities since the early 2000s has triggered substantial interest in the role that China’s housing policy plays in its housing market and macroeconomy, with an extensive literature employing both empirical and theoretical perspectives developed over the past decade. This research finds that the privatization of China’s housing market, which encouraged households living in state-owned housing to purchase their homes at prices far below their market value, contributed to a rapid increase in homeownership beginning in the mid-1990s. Housing market privatization also has led to a significant increase in both housing and nonhousing consumption, but these benefits are unevenly distributed across households. With the policy goal of making homeownership affordable for the average household, the Housing Provident Fund contributes positively to homeownership rates. By contrast, the effectiveness of housing policies to make housing affordable for low-income households has been weaker in recent years. Moreover, a large body of empirical research shows that the unintended consequences of housing market privatization have been a persistent increase in housing prices since the early 2000s, which has been accompanied by soaring land prices, high vacancy rates, and high price-to-income and price-to-rent ratios. The literature has differing views regarding the sustainability of China’s housing boom. On a theoretical front, economists find that rising housing demand, due to both consumption and investment purposes, is important to understanding China’s prolonged housing boom, and that land-use policy, which influences the supply side of the housing market, lies at the center of China’s housing boom. However, regulatory policies, such as housing purchase restrictions and property taxes, have had mixed effects on the housing market in different cities. In addition to China’s housing policy and its direct effects on the nation’s housing market, research finds that China’s housing policy impacts its macroeconomy via the transmission of house price dynamics into the household and corporate sectors. High housing prices have a heterogenous impact on the consumption and savings of different types of households but tend to discourage household labor supply. Meanwhile, rising house prices encourage housing investment by non–real-estate firms, which crowds out nonhousing investment, lowers the availability of noncollateralized business loans, and reduces productive efficiency via the misallocation of capital and managerial talent.

Article

Brant Abbott and Giovanni Gallipoli

This article focuses on the distribution of human capital and its implications for the accrual of economic resources to individuals and households. Human capital inequality can be thought of as measuring disparity in the ownership of labor factors of production, which are usually compensated in the form of wage income. Earnings inequality is tightly related to human capital inequality. However, it only measures disparity in payments to labor rather than dispersion in the market value of the underlying stocks of human capital. Hence, measures of earnings dispersion provide a partial and incomplete view of the underlying distribution of productive skills and of the income generated by way of them. Despite its shortcomings, a fairly common way to gauge the distributional implications of human capital inequality is to examine the distribution of labor income. While it is not always obvious what accounts for returns to human capital, an established approach in the empirical literature is to decompose measured earnings into permanent and transitory components. A second approach focuses on the lifetime present value of earnings. Lifetime earnings are, by definition, an ex post measure only observable at the end of an individual’s working lifetime. One limitation of this approach is that it assigns a value based on one of the many possible realizations of human capital returns. Arguably, this ignores the option value associated with alternative, but unobserved, potential earning paths that may be valuable ex ante. Hence, ex post lifetime earnings reflect both the genuine value of human capital and the impact of the particular realization of unpredictable shocks (luck). A different but related measure focuses on the ex ante value of expected lifetime earnings, which differs from ex post (realized) lifetime earnings insofar as they account for the value of yet-to-be-realized payoffs along different potential earning paths. Ex ante expectations reflect how much an individual reasonably anticipates earning over the rest of their life based on their current stock of human capital, averaging over possible realizations of luck and other income shifters that may arise. The discounted value of different potential paths of future earnings can be computed using risk-less or state-dependent discount factors.

Article

The Hou–Xue–Zhang q-factor model says that the expected return of an asset in excess of the risk-free rate is described by its sensitivities to the market factor, a size factor, an investment factor, and a return on equity (ROE) factor. Empirically, the q-factor model shows strong explanatory power and largely summarizes the cross-section of average stock returns. Most important, it fully subsumes the Fama–French 6-factor model in head-to-head spanning tests. The q-factor model is an empirical implementation of the investment-based capital asset pricing model (the Investment CAPM). The basic philosophy is to price risky assets from the perspective of their suppliers (firms), as opposed to their buyers (investors). Mathematically, the investment CAPM is a restatement of the net present value (NPV) rule in corporate finance. Intuitively, high investment relative to low expected profitability must imply low costs of capital, and low investment relative to high expected profitability must imply high costs of capital. In a multiperiod framework, if investment is high next period, the present value of cash flows from next period onward must be high. Consisting mostly of this next period present value, the benefits to investment this period must also be high. As such, high investment next period relative to current investment (high expected investment growth) must imply high costs of capital (to keep current investment low). As a disruptive innovation, the investment CAPM has broad-ranging implications for academic finance and asset management practice. First, the consumption CAPM, of which the classic Sharpe–Lintner CAPM is a special case, is conceptually incomplete. The crux is that it blindly focuses on the demand of risky assets, while abstracting from the supply altogether. Alas, anomalies are primarily relations between firm characteristics and expected returns. By focusing on the supply, the investment CAPM is the missing piece of equilibrium asset pricing. Second, the investment CAPM retains efficient markets, with cross-sectionally varying expected returns, depending on firms’ investment, profitability, and expected growth. As such, capital markets follow standard economic principles, in sharp contrast to the teachings of behavioral finance. Finally, the investment CAPM validates Graham and Dodd’s security analysis on equilibrium grounds, within efficient markets.

Article

Life-cycle choices and outcomes over financial (e.g., savings, portfolio, work) and health-related variables (e.g., medical spending, habits, sickness, and mortality) are complex and intertwined. Indeed, labor/leisure choices can both affect and be conditioned by health outcomes, precautionary savings is determined by exposure to sickness and longevity risks, where the latter can both be altered through preventive medical and leisure decisions. Moreover, inevitable aging induces changes in the incentives and in the constraints for investing in one’s own health and saving resources for old age. Understanding these pathways poses numerous challenges for economic models. The life-cycle data is indicative of continuous declines in health statuses and associated increases in exposure to morbidity, medical expenses, and mortality risks, with accelerating post-retirement dynamics. Theory suggests that risk-averse and forward-looking agents should rely on available instruments to insure against these risks. Indeed, market- and state-provided health insurance (e.g., Medicare) cover curative medical expenses. High end-of-life home and nursing-home expenses can be hedged through privately or publicly provided (e.g., Medicaid) long-term care insurance. The risk of outliving one’s financial resources can be hedged through annuities. The risk of not living long enough can be insured through life insurance. In practice, however, the recourse to these hedging instruments remains less than predicted by theory. Slow-observed wealth drawdown after retirement is unexplained by bequest motives and suggests precautionary motives against health-related expenses. The excessive reliance on public pension (e.g., Social Security) and the post-retirement drop in consumption not related to work or health are both indicative of insufficient financial preparedness and run counter to consumption smoothing objectives. Moreover, the capacity to self-insure through preventive care and healthy habits is limited when aging is factored in. In conclusion, the observed health and financial life-cycle dynamics remain challenging for economic theory.