Investor Demand in Financial Markets: Frictions and Implications
Paper Session
Friday, Jan. 5, 2024 2:30 PM - 4:30 PM (CST)
- Chair: Judit Temesvary, Federal Reserve Board
International Portfolio Frictions
Abstract
We study patterns and implications of global asset allocations of European insurersand banks using newly available supervisory data. We show that the total assets of
insurance companies and pension funds (ICPF) far exceed the amount of government
bonds outstanding in Europe, and that countries with a large ICPF sector tend to have
a large corporate bond market. Despite high levels of international investments, the
characteristics of domestic financial markets still loom large in insurers’ and banks’
portfolio allocation, with two newly documented international portfolio frictions playing
a prominent role. First, when investing abroad, insurers and banks do not offset
attributes of the domestic markets (such as the composition of fixed-income markets,
interest rates, and sovereign credit risk), which we label “domestic projection bias.” Second,
subsidiaries of multinational groups act like local entities, which we label the “going
native bias.” We propose a theoretical framework to explain our empirical findings and
discuss the broader policy implications for European capital market deepening and
integration, monetary policy transmission and financial stability, and a multi-sectoral
approach to regulatory design.
Institutional Investors, Securities Lending and Short-Selling Constraints
Abstract
Institutional ownership is thought to facilitate short-selling. Indeed, short sellers typically borrow from the holdings of institutions. Yet, institutional demand, and hence lending supply, is endogenous. This paper isolates changes in this demand due to investment mandates (benchmark indexes) to shed new light on the role of institutions in lending markets. In a model with benchmarked fund managers who supply their risky holdings for lending, the equilibrium price and lending supply are both higher for the benchmark asset. Larger supply alleviates short-selling constraints while higher shorting demand (due to inflated price) exacerbates them. Two quasi-natural experiments, the Russell index reconstitution and the Bank of Japan purchases, confirm that stocks with more institutional capital benchmarked against them have larger lending supply and demand. Ultimately, they are costlier to short. In both theory and data, results are driven by incomplete pass-through from institutional holdings to lending supply.Central Banker to the World: Foreign Reserve Management and U.S. Money Market Liquidity
Abstract
We show theoretically and empirically that the dollar’s status as the global reserve currency exposesU.S. money market liquidity to the foreign countries’ real net export shocks. We develop
a model in which U.S. money market spreads respond to foreign central banks’ exchange-rate
management decisions, which are driven by shocks to their net export position. In response to
an increase in export-price volatility, foreign central banks remove liquidity from U.S. money
markets and cause spreads to widen by selling Treasuries to supply liquidity to their financial
systems. Regression analysis shows that shifts in the central banks’ demand for dollar liquidity
related to oil price volatility are associated with elevated spreads in domestic money markets.
A one-standard-deviation increase in the demand for dollar liquidity by a central bank in an
oil-exporting country leads to a two to six basis point increase in spreads and an average of
$3B in Treasury sales. Consistent with our model’s predictions, higher oil-price volatility also
induces deposits with the Federal Reserve to rise.
Discussant(s)
Benoit Nguyen
,
Bank of France
Amiyatosh Purnanandam
,
University of Michigan
Sebastian Infante
,
Federal Reserve Board
Fabricius Somogyi
,
Northeastern University
JEL Classifications
- E4 - Money and Interest Rates
- F3 - International Finance