Seminar für Wirtschaftspolitik (Prof. Haufler)




Current Research Projects

Taxation and Regulation of the Financial Sector

Andreas Haufler, Daniel Gietl and Bernhard Kassner, joint with Frank Heinemann and Ciril Bosch-Rosa, TU Berlin

Project funded within the Collaborative Research Centre TRR 190: Rationality and Competition

First phase: 2017-2020,    Second phase: 2021-2024

This project analyses the interactive effects of incentives and behavioral traits on financial market stability. There are at least two important reasons why financial markets depart from textbook models of efficient, competitive equilibria. First, overconfident behavior of traders and non-rational expectations are pervasive and well-documented features in these markets. Second, traders (and banks) face a fundamental incentive to engage in excessive risk-taking due to incentive structures and implicit or explicit government guarantees. In this project, we aim to investigate how behavioral traits and incentives arising from limited liability interact and how regulation and tax policies should respond in order to increase the resilience of financial markets. Our research project, thus, brings together elements from the theory of financial markets with recent research in behavioral economics.

In the first funding phase, we established experimentally that moral-hazard incentives change the beliefs of subjects, and lead them to overestimate their probability of success. We also developed a new tool to measure overprecision, which is a type of overconfidence by which one has excessive faith in the accuracy of one’s knowledge. This bias is viewed as being one of the most important behavioral traits among finance professionals. In further experiments, we could show that rising asset prices increase the overprecision of subjects trading these assets. In the theoretical part, we focused on the role that bonus payments play in the competition of banks operating under limited liability. We established, among other results, that manager overconfidence further increases the incentives of banks to offer high bonuses, as this pay structure allows them to benefit from the manager’s biased beliefs and from taxpayer subsidies at the same time. In order to internalize these effects, bonuses should be taxed more than other income.

Our research agenda for the second funding phase builds on these results und supplements the theoretical and experimental research strands of the first phase with econometric studies. A first, theoretical part incorporates the observed heterogeneity in the degree of overconfidence and studies how managers with different beliefs sort into a heterogeneous banking sector. We analyze how the effects of behavioral biases arising from overconfidence are propagated in the competitive matching equilibrium, and we derive welfare-improving tax and regulatory policies. In the second, econometric part, we introduce our new measure of overconfidence in a set of survey questions for the German Socioeconomic Panel (SOEP) and test its power in explaining financial and non-financial choices made by SOEP respondents. This part also uses established revealed beliefs measures of overconfidence to test whether overconfident bank managers match limited liability banks in the way predicted by theory. In the third, experimental part, we aim to provide explanations for the highly relevant, but poorly understood, formation of asset market bubbles. We use asset-market experiments that focus on the roles that overconfidence, bonus payments and beliefs each play in bubble formation.

Selected publications from the first research phase:

  • Bosch-Rosa, Ciril, Meissner, T., Bosch-Domènech, A. (2018). Cognitive bubbles, Experimental Economics, 21(1), 132-153.
  • Gietl, D., Haufler, A. (2018). Bonus taxes and international competition for bank managers. European Economic Review 110, 41-60.
  • Haufler, A., Maier, U. (2019). Regulatory competition in capital standards. A ‘race to the top’ result. Journal of Banking and Finance 106, 180-194.
  • Gietl, D., Kassner, B. (2020). Managerial overconfidence and bank bailouts. Journal of Economic Behavior & Organization 179, 202-222.