Motohiro Yogo

A Survey of Weak Instruments and Weak Identification in Generalized Method of Moments

Weak instruments arise when the instruments in linear instrumental variables (IV) regression are weakly correlated with the included endogenous variables. In generalized method of moments (GMM), more generally, weak instruments correspond to weak identification of some or all of the unknown parameters. Weak identification leads to GMM statistics with nonnormal distributions, even in large samples, so that conventional IV or GMM inferences are misleading. Fortunately, various procedures are now available for detecting and handling weak instruments in the linear IV model and, to a lesser degree, in nonlinear GMM.

Asymptotic Distributions of Instrumental Variables Statistics with Many Instruments

This paper extends Staiger and Stock’s (1997) weak instrument asymptotic approximations to the case of many weak instruments by modeling the number of instruments as increasing slowly with the number of observations. It is shown that the resulting “many weak instrument” approximations can be calculated sequentially by letting first the sample size, and then the number of instruments, tend to infinity. The resulting distributions are given for k-class estimators and test statistics.

What Does Futures Market Interest Tell Us about the Macroeconomy and Asset Prices

Economists have traditionally viewed futures prices as fully informative about future economic activity and asset prices. We argue that open interest could be more informative than futures prices in the presence of hedging demand and limited risk absorption capacity in futures markets. We find that movements in open interest are highly pro-cyclical, correlated with both macroeconomic activity and movements in asset prices. Movements in commodity market interest predict commodity returns, bond returns, and movements in the short rate even after controlling for other known predictors. To a lesser degree, movements in open interest predict returns in currency, bond, and stock markets.

Health and Mortality Delta: Assessing the Welfare Cost of Household Insurance Choice

We develop a pair of risk measures, health and mortality delta, for the universe of life and health insurance products. A life-cycle model of insurance choice simplifies to replicating the optimal health and mortality delta through a portfolio of insurance products. We estimate the model to explain the observed variation in health and mortality delta implied by the ownership of life insurance, annuities including private pensions, and long-term care insurance in the Health and Retirement Study. For the median household aged 51 to 57, the lifetime welfare cost of market incompleteness and suboptimal choice is 3.2% of total wealth.

Debt: Deleveraging or Default

We study a dynamic model of collateralized credit markets with asymmetric information, which allows for a rich set of signaling strategies based on the path of debt and repayment. Whether credit history reveals private information about credit quality depends on the degree of uncertainty in collateral value. When uncertainty is low, good borrowers fully and costlessly separate by deleveraging, that is borrowing a sufficiently high amount such that subsequent repayment reveals the presence of unobservable income. When uncertainty is higher, good borrowers pay an adverse selection cost through a higher interest rate because bad borrowers could default, and asymmetric information is not always resolved.

The Fragility of Market Risk Insurance

Insurers sell retail financial products called variable annuities that package mutual funds with minimum return guarantees over long horizons. Variable annuities accounted for

Quantitative Easing in the Euro Area: The Dynamics of Risk Exposures and the Impact on Asset Prices

1.5 trillion or 34 percent of U.S. life insurer liabilities in 2015. Sales fell and fees increased after the 2008 financial crisis as the higher valuation of existing liabilities stressed risk-based capital. Insurers also made guarantees less generous or stopped offering guarantees entirely to reduce risk exposure. We develop an equilibrium model of insurance markets in which financial frictions and market power are important determinants of pricing, contract characteristics, and the degree of market incompleteness.

Risk of Life Insurers: Recent Trends and Transmission Mechanisms

We use new data on security-level portfolio holdings of institutional investors and households in the euro area to understand the impact of the ongoing asset purchase programme of the European Central Bank (ECB) on the dynamics of risk exposures and on asset prices. We develop a tractable measurement framework to quantify the dynamics of euro-area duration, sovereign and corporate credit, and equity risk exposures as the programme evolves. We propose an instrumental-variables estimator to identify the impact of central bank purchases on sovereign bonds on sovereign bond yields. Our results suggest that the foreign sector sells most in response to the programme, followed by banks and mutual funds, while the purchases of insurance companies and pension funds are positively related to purchases by the ECB.

Is the Insurance Sector at Risk

We summarize recent trends in risk exposure for U.S. life insurers from variable annuities, shadow insurance, securities lending, and derivatives. We discuss how these sources of risk could be amplified and transmitted to the rest of the financial sector and the real economy. More complete and transparent financial statements are necessary to accurately assess the overall risk mismatch in the insurance industry. We suggest ways to disclose relevant information and discuss some implications for insurance regulation.

Testing for Weak Instruments in Linear IV Regression

In the wake of the financial crisis, the insurance sector has been overlooked. Ralph SI Koijen and Motohiro Yogo shed new light on the rise of shadow insurance and increasing risk levels in American life insurance markets.