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WORK IN PROGRESS

Managerial Habit Formation and Predictability

Dividend growth rates, dividend-price ratio, dividend smoothing, habit formation, return predictability

JEL classification: C53, G35

In a dynamic agency model where managers prioritize rent-seeking over firm value optimization, habit formation leads to dividend smoothing. Within this framework, we demonstrate that the persistence of the log dividend-price ratio increases with managerial habit persistence. Greater habit persistence can enhance the predictability of log returns and log dividend growth rates. However, this relationship is non-linear, and with extreme habit persistence, the predictability of log dividend growth rates diminishes. Our theoretical findings offer a plausible explanation why the S&P500’s log dividend growth rates were predictable pre-WWII but not post-WWII, while log returns were unpredictable pre-WWII but appear predictable post-WWII.

EU ETS Market Expectations and Rational Bubbles, with Robinson Kruse-Becher and Tony Klein.

[Working Paper] (Updated: 11 December 2024)

Allowance pricing, bubbles, cap-and-trade, EU ETS

JEL classification: C15, G14, Q48, Q56

Serious concerns about the existence of a price bubble within the European Union Emissions Trading System (EU ETS) emerged during its third trading period. Existing bubble tests based on costs for switching from cheap, polluting to costly, clean energy sources are restricted to situations of market certainty. This limitation is unrealistic, considering the ongoing CO2 reduction measures. Additionally, the fundamental value is not uniquely identified, leading to inconclusive empirical findings. We apply a robust approach to infer bubbles in the EU ETS. Our findings do not support the presence of a bubble in the third or fourth trading period.

House Prices and Monetary Policy: Tearing down the wall in Germany?, with Tobias Basse.

[Working Paper] [Online Appendix]

Financial bubbles, monetary policy, house prices, Leaning-against-the-wind

JEL classification: C58, G12, E58

The German housing market, an important segment within the Eurozone, has experienced strong price increases in recent years. This study explores the potential impact of the European Central Bank's (ECB) policies on this price surge. By employing unit root and co-explosiveness tests, we infer explosive trends in German real estate prices and a connection to the ECB's balance sheet volume. Our findings suggest a nuanced relationship wherein ECB policies may have either fueled housing market rises or refrained from responding to these dynamics. Theoretical arguments support that the ECB contributed to the surge instead of merely allowing it to occur.

Riding the bubble or hedging the burst?, with Robinson Kruse-Becher.

Asset price bubble, explosive time series, financial risk measures, stochastic dominance

JEL classification: C22, C44, C58, G01, G17, G28 

Financial risk management matters, especially during crash phases following upon periods of exuberance. Bubbles, as a leading example for such behavior, are widely studied and empirically well established in the literature. However, the impact of financial bubbles, characterized by explosive price increases followed by sharp declines, on risk management has not been fully explored. We theoretically study the terminal wealth distributions of agents with risk-limited investments in a time-discrete stochastic bubble framework with random crashes. Our model allows for flexible modeling of both abrupt and smooth collapses. Agents might either ride the bubble or hedge against its burst (while ignoring the bubble is a special case of the hedging strategy). To compare the two distinct strategies, we apply a novel notion of stochastic dominance (SD) bridging first- and second-order SD. We thus establish conditions for the two mutually exclusive situations of (i) concave (risk-avoiding) SD of the terminal wealth distribution under hedging over riding the bubble and (ii) convex (risk-loving) SD of the terminal wealth distribution under riding over hedging. In an empirical application to 152 historic explosive episodes in 24 major stock markets, we find evidence that there are risk-averse investors preferring the riding over the hedging strategy, provided that the agents can liquidate their collapsing asset in a short period of time (i.e., within 1 or 2 trading days).