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Cecilia Melo Fernandes

6 August 2021
This paper investigates the impact of ECB communication of its assessment of the economic outlook on ex-ante inflation uncertainty and sheds light on how central bank information shocks operate. The paper finds that ECB communication of new outlook information not only reduces professional forecasters’ disagreement (i.e., the cross-sectional dispersion of their average point forecasts of inflation) but also makes forecasters less uncertain about their own beliefs, thus reducing ex-ante average individual uncertainty. By combining and exploiting these types of ex-ante inflation uncertainty, results suggest that central bank information acts as a “coordination device” able to influence opinions and actions. Most importantly, it generates a “stabilizer effect” by substantially decreasing the dispersion among the inflation point forecasts, which converge towards their unconditional aggregate mean. The results of this paper not only help to explain the impact of new central bank information, but they are also useful for policymakers to define a communication strategy that attenuates ex-ante inflation uncertainty in the most effective way.
JEL Code
D83 : Microeconomics→Information, Knowledge, and Uncertainty→Search, Learning, Information and Knowledge, Communication, Belief
E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy
E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies
E65 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Studies of Particular Policy Episodes
G14 : Financial Economics→General Financial Markets→Information and Market Efficiency, Event Studies, Insider Trading
22 January 2021
The cost of equity for banks equates to the compensation that market participants demand for investing in and holding banks’ equity, and has important implications for the transmission of monetary policy and for financial stability. Notwithstanding its importance, the cost of equity is unobservable and therefore needs to be estimated. This occasional paper provides estimates of the cost of equity for listed and unlisted euro area banks using a three-step methodology. In the first step, ten different models are estimated. In the second step, the models’ results are combined applying an equal-weighting procedure. In the third step, the combined costs of equity for individual banks are aggregated at the euro area level and according to banks’ business models. The results suggest that, since the Great Financial Crisis of 2007-08, the premia that investors demand to compensate them for the risk they bear when financing banks’ equity has been persistently higher than the return on equity (ROE) generated by banks. We show that our estimates of cost of equity have plausible relationships to banks’ fundamentals. The cost of equity tends to be higher for banks that are riskier (higher non-performing loan ratios), less efficient (higher cost-to-income ratio), and with more unstable funding sources (higher relative reliance on interbank deposits). Finally, we use bank fundamentals to estimate the cost of equity for unlisted banks. In general, unlisted banks are found to have a somewhat lower cost of equity compared to listed banks, with business model characteristics accounting for part of the estimated difference.
JEL Code
G20 : Financial Economics→Financial Institutions and Services→General
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
G1 : Financial Economics→General Financial Markets