Ricardo T. Fernholz

A Model of Economic Mobility and the Distribution of Wealth

This paper introduces new techniques to obtain a closed-form rank-by-rank characterization of the equilibrium distribution of wealth in a model in which finitely lived households face uninsurable idiosyncratic investment risk. A central result is that the extent of inequality is determined entirely by two factors. The first factor, household exposure to idiosyncratic investment risk, increases inequality. The second factor, cross-sectional mean reversion of household wealth, decreases inequality. We show that economic mobility is decreasing in inequality and increasing in mean reversion, a result that is consistent with recent empirical observations about the geographic variation in mobility that exists both domestically and internationally. Our approach allows us to examine the implications of increased market completeness in the form of a risk-sharing subgroup of households. We show that a risk-sharing subgroup rises or falls in the equilibrium wealth distribution depending on the level of inequality, and that its presence raises welfare and the rate of wealth accumulation for all households in the economy.

The distributional effects of progressive capital taxes

Abstract Rising inequality since the 1980s has spurred much research examining the underlying causes and potential policy responses. Among the more controversial, One of the more controversial policy proposals is a progressive capital tax in response to rising top wealth shares around the world proposes a progressive capital tax in response to rising top wealth shares around the world. This paper introduces rank-based econometric methods for dynamic power laws as a tool for estimating the effect of progressive capital taxes on the distribution of wealth under different assumptions about the impact of these taxes on household behavior. In most scenarios, we find that a small tax levied on 1% of households would substantially reshape the US wealth distribution and reduce inequality.

A Statistical Model of Inequality

This paper develops a nonparametric statistical model of wealth distribution that imposes little structure on the fluctuations of household wealth. In this setting, we use new techniques to obtain a closed-form household-by-household characterization of the stable distribution of wealth and show that this distribution is shaped entirely by two factors - the reversion rates (a measure of cross-sectional mean reversion) and idiosyncratic volatilities of wealth across different ranked households. By estimating these factors, our model can exactly match the U.S. wealth distribution. This provides information about the current trajectory of inequality as well as estimates of the distributional effects of progressive capital taxes. We find evidence that the U.S. wealth distribution might be on a temporarily unstable trajectory, thus suggesting that further increases in top wealth shares are likely in the near future. For capital taxes, we find that a small tax levied on just 1% of households substantially reshapes the distribution of wealth and reduces inequality.

Why Are Big Banks Getting Bigger

The U.S. banking sector has become substantially more concentrated since the 1990s, raising questions about both the causes and implications of this consolidation. We address these questions using nonparametric empirical methods that characterize dynamic power law distributions in terms of two shaping factors — the reversion rates (a measure of crosssectional mean reversion) and idiosyncratic volatilities of assets for different size-ranked banks. Using quarterly data for subsidiary commercial banks and thrifts and their parent bank-holding companies, we show that the greater concentration of U.S. bank-holding company assets is a result of lower mean reversion, a result consistent with policy changes such as interstate branching deregulation and the repeal of Glass-Steagall. In contrast, the greater concentration of both U.S. commercial bank and thrift assets is a result of higher idiosyncratic volatility, yet, idiosyncratic volatility of parent bank-holding company assets fell. This contrast suggests that diversification through non-banking activities has reduced the idiosyncratic asset volatilities of the largest bank-holding companies and affected systemic risk.

Terrorism and the Invisible Hook

This article investigates and compares the root causes of transnational terrorism and piracy. In order to accomplish this, we construct a novel data set that catalogues terrorist activity and piracy over the years 1992–2008, paying particular attention to the Arabian Sea and Indian Ocean since 1991. These data are then merged with other information detailing the economic, political, and security posture of each organization during the same period so that we can examine the relationship between economic prosperity, security, terrorism, and piracy. The main conclusion is that terrorism is mostly unrelated to economic conditions, while piracy responds to both economic payoffs and military deterrents.

Exchange Rate Manipulation And Constructive Ambiguity

I consider dynamic models in which investors are heterogeneously informed about both foreign exchange interventions and exchange rate fundamentals and show that transparency sometimes exacerbates misalignment between the exchange rate and fundamentals. Although transparency reveals information about fundamentals, it also increases the precision of the exchange rate as a signal of those fundamentals that remain unknown (the signal‐precision effect of transparency). If a central bank announcement reveals little information about fundamentals, then this effect dominates and transparency magnifies misalignment. One implication is that ambiguity can increase the effectiveness of intervention to support a declining currency during times of crisis.

The Rank Effect for Commodities

We uncover a large and significant low-minus-high rank effect for commodities across two centuries. There is nothing anomalous about this anomaly, nor is it clear how it can be arbitraged away. Using nonparametric econometric methods, we demonstrate that such a rank effect is a necessary consequence of a stationary relative asset price distribution. We confirm this prediction using daily commodity futures prices and show that a portfolio consisting of lower-ranked, lower-priced commodities yields 23% higher annual returns than a portfolio consisting of higher-ranked, higher-priced commodities. These excess returns have a Sharpe ratio nearly twice as high as the U.S. stock market yet are uncorrelated with market risk. In contrast to the extensive literature on asset pricing factors and anomalies, our results are structural and rely on minimal and realistic assumptions for the long-run properties of relative asset prices.