How Credit Affects Revealed Risk Preferences

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1 Evidence from Home Equity Loans and Voluntary Unemployment Insurance Kristoffer Markwardt Alessandro Martinello László Sándor + SFI and University of Copenhagen + Harvard University

2 Liquidity and risk - empirical evidence What you know already Dah! Risk exposure Risk aversion = Savings Liquidity Life cycle buffers (Carroll, 1997; 2001), committments (Chetty and Szeidl, 2007), constraints (Deaton, 1991; Alessie et al., 1997) But also, wealth used as buffer stock Home equity loans (Hurst & Stafford, 2004) Intuition: Buffer pool = Risk I can take Trading liquidity with risk? Risk Liquidity? What we want to convince you of Yes: people who has more access to liquidity causally take more risk than others: Risk = Liquidity

3 Liquidity and risk - empirical evidence What you know already Dah! Risk exposure Risk aversion = Savings Liquidity Life cycle buffers (Carroll, 1997; 2001), committments (Chetty and Szeidl, 2007), constraints (Deaton, 1991; Alessie et al., 1997) But also, wealth used as buffer stock Home equity loans (Hurst & Stafford, 2004) Intuition: Buffer pool = Risk I can take Trading liquidity with risk? Risk Liquidity? What we want to convince you of Yes: people who has more access to liquidity causally take more risk than others: Risk = Liquidity

4 Liquidity and risk - empirical evidence What you know already Dah! Risk exposure Risk aversion = Savings Liquidity Life cycle buffers (Carroll, 1997; 2001), committments (Chetty and Szeidl, 2007), constraints (Deaton, 1991; Alessie et al., 1997) But also, wealth used as buffer stock Home equity loans (Hurst & Stafford, 2004) Intuition: Buffer pool = Risk I can take Trading liquidity with risk? Risk Liquidity? What we want to convince you of Yes: people who has more access to liquidity causally take more risk than others: Risk = Liquidity

5 Why us Do we care? Relevant for optimal UI design, commitments, role of home equity Micro effects of credit expansions (pre-) and crunches (post-crisis)!problems... 1 Measure preferences for risk 2 Causality ( =): Liquidity endogenous Hard to separate wealth and liquidity shocks (Chetty and Szeidl 2012)... solved: the case of Denmark! 1 UI voluntary and uniform: demand for UI revealed risk preferences 2 Mortgage reform of March 1992 (Leth-Petersen, 2010) Exogenous shock, only for housing equity holders Affected only access to credit (liquidity), not wealth

6 Why us Do we care? Relevant for optimal UI design, commitments, role of home equity Micro effects of credit expansions (pre-) and crunches (post-crisis)!problems... 1 Measure preferences for risk 2 Causality ( =): Liquidity endogenous Hard to separate wealth and liquidity shocks (Chetty and Szeidl 2012)... solved: the case of Denmark! 1 UI voluntary and uniform: demand for UI revealed risk preferences 2 Mortgage reform of March 1992 (Leth-Petersen, 2010) Exogenous shock, only for housing equity holders Affected only access to credit (liquidity), not wealth

7 Why us Do we care? Relevant for optimal UI design, commitments, role of home equity Micro effects of credit expansions (pre-) and crunches (post-crisis)!problems... 1 Measure preferences for risk 2 Causality ( =): Liquidity endogenous Hard to separate wealth and liquidity shocks (Chetty and Szeidl 2012)... solved: the case of Denmark! 1 UI voluntary and uniform: demand for UI revealed risk preferences 2 Mortgage reform of March 1992 (Leth-Petersen, 2010) Exogenous shock, only for housing equity holders Affected only access to credit (liquidity), not wealth

8 Preview: percentage of insured over time Home equity in 1991 Equity: N1= 35710; No Equity: N0= No equity in home

9 The credit market reform Took effect on May 21, 1992; unexpected (Leth-Petersen, AER 2010) Main elements: Expansion of maximum maturity of a real estate loan (from 20) to 30 years Right to remortgage loan Allows to use house as collateral for consumption loans Before 1992: loan only for house purchase 60% of house value from May 1992, 80% from December 1992 Loan against equity = unexpected liquidity shock Only to households with housing equity

10 The credit market reform Took effect on May 21, 1992; unexpected (Leth-Petersen, AER 2010) Main elements: Expansion of maximum maturity of a real estate loan (from 20) to 30 years Right to remortgage loan Allows to use house as collateral for consumption loans Before 1992: loan only for house purchase 60% of house value from May 1992, 80% from December 1992 Loan against equity = unexpected liquidity shock Only to households with housing equity

11 Unemployment insurance in DK Voluntary! Uniform insurance product Cost, requirements and benefits stable over time Centrally regulated stable across funds Small differences in administrative costs and services (e.g. job search) Convenient Benefit cap $1,800 per month Actuarially fair given 2.6% u.r. = High insured % Social security (fallback option) not considered here... almost!

12 Economic environment GDP growth Interest rate Unemployment rate House price index

13 Data - Danish registers 100% Danish population (wealth tax) Primarily tax reports Info on income, wealth, insurance status, demographics, SES... Selection criteria Individuals left All individuals in cohorts Trim financial outliers Balance sample Drop ever out of labor force Drop ever self-employed Drop ever in education Industry-related selection Homeowner in Trim top & bottom 1% of liquidity shock

14 Key variables Liquidity shock L 1991 = 0.8 H1991 M1991 Y P Housing Publicly assessed value, December 31 Loans granted on basis of market price scale by public/market ratio, from housing transactions Mortgage Market value, December 31 Bond price fluctuations = measurement error; noise Only consistently reported 1992 Permanent income Comprise 22 years of wage income ( 87-08) Individuals on different parts of earnings path include as many years as possible

15 Key variables Liquidity shock L 1991 = 0.8 H1991 M1991 Y P Housing Publicly assessed value, December 31 Loans granted on basis of market price scale by public/market ratio, from housing transactions Mortgage Market value, December 31 Bond price fluctuations = measurement error; noise Only consistently reported 1992 Permanent income Comprise 22 years of wage income ( 87-08) Individuals on different parts of earnings path include as many years as possible

16 Descriptives: Home owners in 1991 by size of liquidity shock Q1 Q2 Q3 Q4 Population Liquidity shock Insurance rate Insurance rate Insurance rate Moved to 1991 housing Housing value Mortgage value Permanent income Disposable income Liquid Assets Debts Employment rate Unemployment risk Industry, fewest Mining Fishing Industry, most Metal industry Age Years of schooling Spouse # kids Female N

17 Descriptives: Home owners in 1991 by size of liquidity shock Q1 Q2 Q3 Q4 Population Liquidity shock Insurance rate Insurance rate Insurance rate Moved to 1991 housing Housing value Mortgage value Permanent income Disposable income Liquid Assets Debts Employment rate Unemployment risk Industry, fewest Mining Fishing Industry, most Metal industry Age Years of schooling Spouse # kids Female N

18 Descriptives: Home owners in 1991 by size of liquidity shock Q1 Q2 Q3 Q4 Population Liquidity shock Insurance rate Insurance rate Insurance rate Moved to 1991 housing Housing value Mortgage value Permanent income Disposable income Liquid Assets Debts Employment rate Unemployment risk Industry, fewest Mining Fishing Industry, most Metal industry Age Years of schooling Spouse # kids Female N

19 Discrete treatment Unconditional Conditional Home equity in 1991 No equity in home Home equity in 1991 No equity in home Equity: N1= 35710; No Equity: N0= Equity: N1= 35710; No Equity: N0= 78116

20 Continuous treatment.5.3 %insured in liquidity shock

21 Continuous treatment.5.7 %insured in liquidity shock

22 Continuous treatment.3.1 %insured in liquidity shock

23 Continuous treatment %insured in liquidity shock

24 Continuous treatment %insured in liquidity shock

25 Continuous treatment %insured in liquidity shock

26 Continuous treatment %insured in liquidity shock

27 Continuous treatment %insured in liquidity shock

28 Continuous treatment.9.7 %insured in liquidity shock

29 CONTINUOUS OLS MARG FE LOGIT FE LOGIT 1991 equity 0.959** 4.457** 0.122** (0.117) (0.737) ( ) 1991 equity, post ** ** ** * (0.0871) (0.627) (0.0864) (0.0110) (0.0197) 1991 liquid assets ** (0.239) (0.916) ( ) Permanent income ** ** ** (0.0120) (0.0350) ( ) 1991 debts ** ** ** (0.185) (0.882) ( ) Disposable income ** ** ** 0.961** (0.464) (1.993) (0.271) (0.0166) (0.0520) Unemployment risk 0.896** ** 0.108** ** (0.0253) (0.125) (0.0185) ( ) ( ) N. kids 0.358** ** ** 0.101** (0.0736) (0.421) (0.0603) ( ) (0.0146) Female 1.361** 6.246** 0.144** (0.197) (0.872) ( ) Couple 1.090** 4.048** 0.670** 0.139** 0.243** (0.132) (0.760) (0.105) ( ) (0.0252) Year Yes Yes Yes Yes Yes Cohort Yes Yes No Yes No Industry Yes Yes Yes Yes Yes Education Yes Yes No Yes No Observations

30 DISCRETE OLS MARG FE LOGIT FE LOGIT Treated group 0.794** 2.696** ** (0.166) (1.029) (0.0101) Treatment ** ** (0.123) (0.844) (0.122) (0.0161) (0.0300) 1991 liquid assets ** (0.241) (0.928) ( ) Permanent income ** ** ** (0.0124) (0.0361) ( ) 1991 debts ** ** ** (0.186) (0.902) ( ) Disposable income ** ** ** 0.959** (0.461) (2.058) (0.279) (0.0172) (0.0535) Unemployment risk 0.912** ** 0.109** ** (0.0262) (0.129) (0.0191) ( ) ( ) N. kids 0.395** ** ** 0.111** (0.0761) (0.436) (0.0624) ( ) (0.0151) Female 1.318** 6.247** 0.136** (0.204) (0.903) ( ) Couple 1.038** 4.203** 0.668** 0.130** 0.238** (0.136) (0.788) (0.108) ( ) (0.0259) Year Yes Yes Yes Yes Yes Cohort Yes Yes No Yes No Industry Yes Yes Yes Yes Yes Education Yes Yes No Yes No Observations

31 Robustness check: Stable households OLS MARG FE LOGIT FE LOGIT Continuous ** ** ** (0.0953) (0.674) (0.0873) (0.0122) (0.0254) Discrete ** ** (0.135) (0.909) (0.124) (0.0179) (0.0387) Year Yes Yes Yes Yes Yes Cohort Yes Yes No Yes No Industry Yes Yes Yes Yes Yes Education Yes Yes No Yes No Other controls a Yes Yes Yes Yes Yes Observations, cont Observations, disc Standard errors in parentheses; * p<0.05, ** p<0.01 a Other controls include liquid assets and debts in 1991, permanent income, disposable income, unemployment risk, gender, # kids and a couple indicator.

32 Placebo reforms.3.1 %insured in Hypothetical liquidity shock

33 Placebo reforms.7.9 %insured in Hypothetical liquidity shock

34 Placebo reforms.2 0 %insured in Hypothetical liquidity shock

35 Placebo reforms %insured in Hypothetical liquidity shock

36 Placebo reforms Placebo reform in 1991 Real reform in %insured in %insured in Hypothetical liquidity shock liquidity shock

37 Conclusions Sum up Small but significant effect of access to credit on demand for UI Transaction costs (US), cost-effectiveness of program, gross effect Robust to specifications, placebos, common trend checks Contributions Empirical evidence on effects of liquidity, undocumented Disentangle wealth from liquidity effect House price variation (Chetty & Szeidl, 2012; Hryshko et al.) confound the two

38 Conclusions Sum up Small but significant effect of access to credit on demand for UI Transaction costs (US), cost-effectiveness of program, gross effect Robust to specifications, placebos, common trend checks Contributions Empirical evidence on effects of liquidity, undocumented Disentangle wealth from liquidity effect House price variation (Chetty & Szeidl, 2012; Hryshko et al.) confound the two

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