Shadow Cost Research Articles

The Shadow Cost of Collateral

Abstract We quantify the cost of pledging collateral for small businesses by exploiting a regulatory quirk of the SBA disaster lending program in which firms are exempt from posting collateral if their loan size is below a threshold. Firms bunch their loans below the threshold, and the resulting distortion in the loan size distribution reveals the magnitude of the collateral cost. The collateral cost is substantial and varies across collateral types, business sectors, and collateral laws in ways consistent with flexibility-based theories. Our findings have implications for firms’ borrowing constraints and disaster lending program designs. (JEL E44, E51, G21, G23, G33)

The shadow cost of mobile public bads

We price the transboundary externality of mobile public bads such as diseases and invasive species. We focus on the marginal cost to country B of an increase in the stock (i.e. an “outbreak”) in country A. These cross-jurisdiction marginal costs depend not only on economic, ecological, and spatial features of both jurisdictions but also on jurisdictions’ strategic reactions to the outbreak. Using a spatial dynamic game, we calculate the “cross-jurisdiction shadow costs” of an outbreak of mobile public bad under the Markov-perfect Nash equilibrium of control efforts. We find that under reasonable conditions, the source country has private incentives to control the outbreak itself, which can lead to a situation where the cross-jurisdiction shadow cost is, in fact, zero. We also derive conditions where a country optimally fails to control the outbreak (for example, damages in that country are small), in which case cross-jurisdiction shadow costs are positive. Finally, we note that since cooperative control of the mobile public bad delivers substantially higher welfare than non-cooperative control, we derive an externality pricing instrument that perfectly internalizes the externality and induces cooperative control among all countries.

The Term Structure of Covered Interest Rate Parity Violations

ABSTRACTWe quantify the impact of risk‐based and nonrisk‐based intermediary constraints (IC) on the term structure of covered interest rate parity (CIP) violations. Using a stochastic discount factor (SDF) inferred from interest rate swaps, we value currency derivatives. The wedge between model‐implied and observed derivative prices reflects the impact of nonrisk‐based IC because our SDF incorporates risk‐based IC. There is no wedge at short horizons, while the wedge accounts for 40% of long‐term CIP violations. Consistent with IC theory, the wedge correlates with the shadow cost of intermediary capital, and the SDF‐implied interest rate is a weighted average of collateralized and uncollateralized interest rates.

Intermediary Capital and the Credit Market

We propose a tractable framework to examine the role of intermediary capital in the allocation and pricing of credit. In our model, regulated financial intermediaries compete with unregulated investors, targeting distributions of heterogeneous borrowers. We derive a sufficient statistic that characterizes intermediaries’ cross-sectional lending decisions and provide a novel intermediary asset pricing equation that accounts for the endogenous segmentation of marginal investors across securities. These formulae reveal the central role of intermediaries’ shadow cost of capital in both credit allocation and pricing. Our results can concurrently rationalize a broad array of empirical facts documented in the context of credit markets. This paper was accepted by Tomasz Piskorski, finance. Funding: This work was supported by Marcus och Amalia Wallenbergs minnesfond [Grant 2021.0122].

Infrastructure System Obstacles and Technology Adoption by Firms in Transition Countries

Abstract This study uses business survey data to analyze firm perceptions of infrastructure systems in transition countries as obstacles to conducting business. Factors that contribute to reported perceptions are modeled, including country macroeconomic conditions, firm characteristics, and measures of overall reforms and infrastructure system reforms. Identified obstacles arise from binding constraints that limit economic growth, reflect implicit shadow costs, and signal areas in need of policy reform or infrastructure investment. The analysis covers electric power, telecommunications, transportation, and water and wastewater infrastructure systems. Also examined is whether transition indicators of reforms, intended to reflect improvements, are associated with perceptions of obstacles. Beyond identifying infrastructure obstacles and the effects of reforms during the transition process, we also explore firm adoptions of new electronic technologies, essentially a new infrastructure system, as they use email, websites, cell phones, and high-speed Internet in their business activity.

Environmental policies with the excess burden of public funds and privatisation

AbstractThis study investigates the interaction of environmental policies with the shadow cost of public funds and the efficiency of green research and development (R&D), while considering the presence of a public firm. In the policy combination of emission taxes and green R&D subsidies, we find that it has an implementable region where the shadow cost is neither high nor low, but the green R&D efficiency is high. We also demonstrate that the privatisation of public firms decreases the rates of both emission taxes and green R&D subsidies under a single policy regime. This increases (decreases) the implementable region of the policy combination of the emission tax (green subsidy) and is only implementable in the presence of a public firm. Finally, privatisation is shown to increase welfare when the shadow cost is lowest and green R&D is less efficient. These findings highlight that public ownership substitutes for environmental policies, while the shadow cost of public funds and the green R&D efficiency are critical when privatising public firms.

Pledgeability and Asset Prices: Evidence from the Chinese Corporate Bond Markets

ABSTRACTWe provide causal evidence on the value of asset pledgeability by exploiting a unique feature of Chinese corporate bond markets: bonds with identical fundamentals are traded on two segmented markets with different rules for repo transactions. Using a policy shock that rendered AA+ and AA bonds ineligible for repo on one market only, we compare how bond prices changed across markets and rating classes around this event. When the haircut increases from 0% to 100%, bond yields increase by 39 bps to 85 bps. These estimates help us infer the magnitude of the shadow cost of capital in China.

Life cycle assessment and shadow cost of steam produced by an industrial-sized high-temperature heat pump

Heat pumps are considered to be a promising technology to mitigate industrial emissions from steam provision. In this work, an existing scale-up framework for generating life-cycle inventory data for residential heat pumps was tested if applicable to large-scale high-temperature heat pumps. The benchmark was experimental data from existing machinery. It was found that the scaling framework underestimated the total mass; thus, a new scaling framework was developed and was applied to data obtained from a test run of a commercially available high-temperature pump. A full life cycle assessment was performed by comparing two different steam pressure levels, 2 and 5-bar, produced by the high-temperature heat pump to relevant benchmarks, such as steam from a fossil fuel-driven steam boiler. Although greenhouse gas emissions were reduced by as much as 98% in the best-case scenario, other midpoint categories exhibited a more mixed result in which sometimes the heat pumps were favorable and at other times the benchmarks had a lower impact. An unexpected finding was that the working fluid and its leakage did not have a significant contribution to the global warming potential but it was almost solely responsible for the ozone depletion potential. Recommendations were derived on how to further improve the environmental impact of high-temperature heat pumps. Ultimately, the life cycle impact assessment results were converted into shadow price to allow for a comparison between different areas of protection and to give policymakers an estimate of the total externalized cost of the technology.

Effects of asymmetric investment cost information on revenue-compensated build-operate-transfer highway contracts

In the planning stage of build-operate-transfer (BOT) highway projects, private firms usually possess more information about the investment cost than governments. This study considers the problem of how to design project contracts and regulate private firms whose investment costs are unobservable to governments. A principal-agent model is proposed to investigate this type of BOT contracts, in which governments aim to maximize social welfare, while the firms are guaranteed a reserved level of profit and have no incentive to misreport their costs. Besides, the extent to which the information asymmetries influence these contracts is examined, through an analysis of the effects of the distribution of marginal cost parameters and the shadow cost of public funds. Furthermore, properties of these contracts are discussed and compared with the revenue-compensated BOT contracts under symmetric cost information.

The Price Impact of S&P 500 Affiliation

Abstract We examine how abnormal returns and abnormal return determinants change when a company is added to S&P 500. Newly added companies experience a significant increase in abnormal returns around the announcement and addition dates. This increase is accompanied by an improvement in liquidity and a decrease in associated shadow cost. While before their addition, firm-specific abnormal returns can be explained by price impact, they are explained by changes in trading activity during the addition event. Additionally, companies with higher leverage ratios benefit more from index affiliation.

The Shadow Cost of State Violence: Evidence from Bureaucratic Purges in China

The Shadow Cost of State Violence: Evidence from Bureaucratic Purges in China

Delivery of private toll roads: Incentive strategies for improving service quality and social welfare

Managing the service quality of toll roads delivered by using Public-Private Partnerships (PPPs) to ensure value for money to taxpayers is challenging for governments worldwide. An absence of critical research in this area has exacerbated this challenge. The upshot, in this instance, has been an inability for governments to engender and enact effective incentive strategies to operate and maintain private toll roads. To fill this gap, this paper aims to identify and examine incentive strategies for improving the operational quality of toll roads delivered by private entities. We develop a game model with four scenarios and then compare relevant decision behaviour and social welfare. The analysis reveals that only when the shadow cost of public funds is below a specific threshold there can be a feasible incentive strategy for ensuring quality improvement and higher social welfare. Furthermore, an incentive contract with a predetermined quality can enable a higher operational quality while requiring a higher incentive intensity. The contributions of this research are twofold: (1) we propose an enhanced model that is useful for governments to examine the impacts that different incentive strategies will have on the performance of transport projects; (2) we give an enhanced insight to support decision-making for incentives towards transport asset operations. This research will also be beneficial for governments in enhancing toll roads’ operational quality and social welfare for taxpayers.

Marginal abatement costs for GHG emissions in Canada: a shadow cost approach

This study approximates the marginal abatement costs (MACs) of reducing GHG emissions in Canada using the shadow cost approach. Utilizing industry level data, we are the first to offer Canadian estimates based on a Hyperbolic Output Distance Function (HODF) and the stochastic frontier estimation. Accounting for GHG emissions caused by energy consumption, we obtain an average shadow MAC of $130/t across 30 industries. In the GHG-intensive industries such as the electric utilities and non-conventional oil extraction, MACs are lower than the CO2 levy of $50/t imposed by the federal government. Since these low-MACs sectors account for about 98 per cent of total GHG emissions and 94 per cent of total energy use in industries studied, the envisaged $50/t carbon levy could notionally result in a significant GHG abatement in Canada.Graphical abstractFig. aEstimated Marginal Abatement Costs by Sector

EE211 Shadow Costs of Systemic Corticosteroid-Related Adverse Events in Ulcerative Colitis: A Pharmacoeconomic Evaluation

EE211 Shadow Costs of Systemic Corticosteroid-Related Adverse Events in Ulcerative Colitis: A Pharmacoeconomic Evaluation

Optimal carbon taxation in EU frontrunner countries: coordinating with the EU ETS and addressing leakage

ABSTRACT Several EU countries have targets for the reduction of CO2e emissions that go beyond the target set by the EU. We study what would be the optimal carbon tax policy in such EU frontrunner countries, focusing on two questions: 1) How should national climate policy be coordinated with the European Emissions Trading System (ETS), and 2) How should an EU frontrunner country address the risk of carbon leakage? We show that these issues are closely linked and that the answers to the two questions depend on the following factors: i) The shadow cost assigned to carbon leakage, ii) The rates of carbon leakage in the ETS and non-ETS sectors, and iii) The price of ETS emission allowances relative to the domestic marginal abatement cost of attaining the desired reduction of domestic emissions. Our analysis shows that it is preferable for an EU frontrunner country to implement a national ETS sector carbon tax that results in a higher total carbon price in the national ETS sector compared to the national non-ETS sector. We illustrate how our theoretical model can be combined with a modified version of the GTAP-E general equilibrium model of the world economy to estimate the parameters of the optimal national carbon tax scheme in an EU frontrunner country, using Denmark as an example. We find that the ETS sector should pay a total carbon price that is between 33 and 78 percent above that of the rest of the economy depending on the aversion to carbon leakage. Key policy insights It is generally optimal for an EU frontrunner country – one with a domestic emission target beyond that set by the EU – to implement a national ETS sector tax. The total national carbon price should be higher in the ETS sector compared to the non-ETS sector. Data for Denmark indicate that the total national ETS sector carbon price should be at least 33 percent higher than that of the national non-ETS sector.

Are Intermediary Constraints Priced?

AbstractViolations of no-arbitrage conditions measure the shadow cost of intermediary constraints. Intermediary asset pricing and intertemporal hedging together imply that the risk of these constraints tightening is priced. We describe a “forward CIP trading strategy” that bets on CIP violations shrinking and show that its returns help identify the price of this risk. This strategy yields the highest returns for currency pairs associated with the carry trade. The strategy’s risk substantially contributes to the volatility of the stochastic discount factor, is correlated with both other near-arbitrages and intermediary wealth measures, and appears to be consistently priced across various asset classes.Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

Resource Allocation in Bank Supervision: Trade‐Offs and Outcomes

ABSTRACTWe estimate a structural model of resource allocation on work hours of Federal Reserve bank supervisors to disentangle how supervisory technology, preferences, and resource constraints impact bank outcomes. We find a significant effect of supervision on bank risk and large technological scale economies with respect to bank size. Consistent with macroprudential objectives, revealed supervisory preferences disproportionately weight larger banks, especially post‐2008 when a resource reallocation to larger banks increased risk on average across all banks. Shadow cost estimates show tight resources around the financial crisis and counterfactuals indicate that binding constraints have large effects on the distribution of bank outcomes.

Social Efficiency of Market Entry Under Tax Policy

Abstract We provide a new rationale for socially insufficient market entry. We show that if the shadow cost of public funds is sufficiently high, the number of firms under free entry can be socially insufficient if the tax policies are “time inconsistent”, so that the governments cannot commit to the tax policies before market entry of firms. Hence, strategic tax policies may provide a reason why policymakers should engage in pro-competitive policies. Lump-sum subsidies to firms may be a way to achieve that goal.

The Shadow Costs of Illiquidity

AbstractWe solve a flexible model that captures transactions costs and infrequencies of trading opportunities for illiquid assets to better understand the shadow costs of illiquidity for different origins of asset illiquidity and heterogeneous investor types. We show that illiquidity that results in suboptimal asset allocation carries low shadow costs, whereas these costs are high when illiquidity restricts consumption. As a result, the shadow costs are high for short-term investors, investors who face substantial liquidity shocks, and investors who desire to allocate a large fraction of their wealth to illiquid assets.

Does integrated soil fertility management increase returns to land and labor?

AbstractIntegrated Soil Fertility Management (ISFM) is promoted to enhance soil fertility and agricultural productivity among smallholders. Its core is the combined use of organic and inorganic fertilizers with improved crop varieties. Adoption of these practices potentially involves additional monetary and labor investments, and it remains unclear whether these pay off. This study analyzes the effects of the three core ISFM practices and their combinations on key agricultural outcomes, including land and labor productivity as well as net crop value, in which we account for the shadow costs of unpaid labor. We employ a multinomial endogenous switching model to original survey data from over 6000 teff, maize and wheat plots owned by around 2000 households in Ethiopia. All ISFM practices and their combinations increase land and labor productivity, despite higher labor demand, with the largest effects stemming from the joint use of all three practices. Effects on net crop value are positive for most combinations, but suggest that organic fertilizer with improved seeds may be more beneficial compared to combinations with inorganic fertilizer. The importance of organic fertilizer applications is also supported by our regionally disaggregated analysis that reveals important agroecological heterogeneity.