Bernd Schlusche

Asset Price Bubbles: A Survey

Why do asset price bubbles continue to appear in various markets? What types of events give rise to bubbles and why do arbitrage forces fail to quickly burst them? Do bubbles have real economic consequences and should policy makers do more to prevent them? This paper provides an overview of recent literature on bubbles, with significant attention given to behavioral models and rational models with frictions. The latest U.S. real estate bubble is described in the context of this literature.

Price Formation in Spot and Futures Markets: Exchange Traded Funds vs. Index Futures

This article examines the issue of price leadership between a derivative and its underlying—in this case, the German DAX index and an exchange-traded fund (ETF) based on the DAX portfolio of stocks. Previous researchers had found that changes in DAX futures prices led movements in the underlying DAX index. Schlusche tests to see whether that result carries over to DaxEx, the DAX ETF traded on the EUREX exchange. He shows that both markets contribute to price discovery, but the influence of the DAX futures is about three times greater than the influence of the ETF. Digging more deeply into the relationship, he finds that the relative importance of the two markets in price determination varies over time, with the ETF carrying greater weight in times of higher volatility, while variations in relative trading volume, which he takes to be a measure of relative liquidity, do not seem to matter.

Asset Bubbles: an Application to Residential Real Estate

Behavioural models offer new insights into why bubbles are ubiquitous in residential real estate markets. These markets are dominated by unsophisticated households who often develop optimistic views by extrapolating from past returns. Rational investors cannot easily trade against an overvaluation of housing assets because of high transaction costs and a binding short sale constraint. Circumventing the effect of the latter, the supply of housing frequently increases in response to rising prices. This helps to mitigate bubbles but often leads to overbuilding, which slows down the recovery after a bubble bursts. Models that incorporate the effects of perverse incentives and limits to arbitrage are especially helpful in explaining the bubble that developed in mortgage‐backed securities and helped fuel the recent real estate bubble by relaxing home buyers’ borrowing constraints. The literature is ambiguous about whether governments should intervene to burst bubbles, as a better response may lie in improving incentives of key market players.

Economic Linkages Inferred from News Stories and the Predictability of Stock Returns

We show that news stories contain information about economic linkages between firms and document that information diffuses slowly across linked stocks. Specifically, we identify linked stocks from co-mentions in news stories and find that linked stocks cross-predict one anothers returns in the future. Our results indicate that information can flow from smaller to larger stocks and across industries. Content analysis of common news stories reveals many types of firm linkages that have not been previously studied. We find that the cross-predictability in returns remains even after firm pairs with customer-supplier ties are removed. Results show that both limited attention and slow processing of complex information contribute to slow information diffusion.

Performance Isn't Everything: Personal Characteristics and Career Outcomes of Mutual Fund Managers

We investigate the determinants of mutual fund manager career outcomes. We find that, although career outcomes are largely determined by past performance, measured by returns and fund flows, personal attributes also factor in. All else equal, female managers are less likely to be promoted and have shorter tenures than male fund managers. This finding applies to a greater extent to women who co-manage funds with other managers, which suggests that working in teams negatively affects womens careers when compared to mens. Moreover, we show that, all else equal, younger managers, U.S.-educated managers, and managers who attended elite schools experience better career outcomes than otherwise similar managers.

Demand for M2 at the Zero Lower Bound: The Recent U.S. Experience

In this paper, we re-examine the relationship between money and interest rates with a focus on the past few years, when the opportunity cost of M2 has dropped below zero. Until the late 1980s, a stable relationship between monetary aggregates and the opportunity cost of holding money--measured as the spread between the three-month Treasury bill yield and the deposit-weighted average return on M2 assets--existed, and played an integral role in the conduct of monetary policy (e.g., Moore et al.(1990)). This relationship broke down in the early 1990s, when M2 velocity increased beyond the range that could be explained by movements in M2 opportunity cost. As of the mid-2000s, a new relationship was emerging, but was still statistically unstable. In late 2008, the opportunity cost of holding money dropped precipitously and has remained at its zero lower bound. Standard money-demand theory indicates that in such cases the interest elasticity of money demand should rise sharply. Reviewing the evidence to date, we fail to find support for such a rise through 2011, but we observe a notable change in the relationship over the most recent quarters. We conjecture that the more recent shifts, however, could be due to the effects of regulatory and monetary policy changes rather than a fundamental shift in the relationship between money and opportunity cost. Further work is needed to determine the contribution of these regulatory and monetary policy factors.

The Federal Reserve's Balance Sheet and Overnight Interest Rates

This paper provides a comprehensive study of the interplay between the Federal Reserves balance sheet and overnight interest rates. We model both the supply of and the demand for excess reserves, treating assets of the Federal Reserve as policy tools, and estimate the effects of conventional and unconventional monetary policy on overnight funding rates. We find that, in the current environment with quite elevated levels of reserves, the effect of further monetary policy accommodation on overnight interest rates is limited. Further, assuming a path for removing monetary policy accommodation that is consistent with the FOMCs exit principles, we project that the federal funds rate increases to 70 basis points, settling in a corridor bracketed by the discount rate and the interest rate on excess reserves, as excess reserves of depository institutions decline to near zero.