This document summarizes a research paper that develops a dynamic stochastic general equilibrium (DSGE) model to explain how monetary policy affects risk in financial markets and the macroeconomy. The key feature of the model is that asset and goods markets are segmented because it is costly for households to transfer funds between the markets. The model generates endogenous movements in risk as the fraction of households that rebalance their portfolios varies over time in response to real and monetary shocks. Simulation results indicate the model can account for evidence that monetary policy easing reduces equity premiums and helps explain the response of stock prices to monetary shocks.
This document summarizes a research paper that examines how financial distress affects the cross-section of equity returns. The paper develops a simple model that considers financial leverage in equity valuation and the potential for shareholder recovery during financial distress. The model shows that the possibility of shareholder recovery can reduce equity risk for highly distressed stocks. This helps explain various empirical patterns, such as lower returns for distressed stocks, stronger value effects for high default risk firms, and momentum profits concentrated in low credit quality stocks. The model predicts a hump-shaped relationship between value premiums and default probability, as well as stronger momentum profits for nearly distressed firms with higher potential recovery. Empirical tests on market data generally confirm these predictions.
COMPLEMENTARY CURRENCY AND ITS IMPACT ON THE ECONOMYIFLab
This document analyzes the potential impact of complementary currencies on a national economy. It begins by discussing how money is created in traditional capitalist economies through a two-stage process of central banks issuing debt and commercial banks providing loans. It then presents a system dynamics model to describe money issuance in economies with and without "inside money". As an example, it analyzes outcomes of a barter network in El Salvador and calculates spending multipliers. The main finding is that digital community currencies have greater spending multipliers than regular money markets. While the analyzed network is currently small, it could help cushion macroeconomic shocks by stabilizing aggregate demand.
This document summarizes a research paper that develops a dynamic general equilibrium model to analyze systemic risk in the banking sector. The key aspects of the model are that it includes banks that engage in maturity transformation by issuing non-state contingent debt, and the banks are exposed to risks in capital markets that can affect their solvency. The model shows that individual banks in a competitive system will take on excessive systemic risk due to pecuniary externalities, leading to a higher crisis probability than the socially optimal level. The document then discusses using prompt corrective action (PCA) policies to reduce crisis risk by strengthening bank capital requirements.
Does Liquidity Masquerade As Size FinalAshok_Abbott
he empirical results presented in this paper suggest a strong role for liquidity in explaining higher raw and excess returns realized by investors in less liquid stocks. Size effect has been studied extensively and it has been suggested that it may be a proxy for another unobserved factor. Our results strongly suggest that liquidity may be that unobserved factor explaining a large part but not all of the size premium.
This paper introduces an imperfectly competitive banking sector into a DSGE model to study the role of credit supply factors in business cycle fluctuations in the euro area. Banks issue loans to households and firms, obtain funding via deposits, and accumulate capital from retained earnings. Margins on loans depend on bank capital ratios and interest rate stickiness. Estimating the model with euro area data from 1999-2008, the paper finds that:
1) Shocks originating in the banking sector explain most of the output fall in 2008, while macroeconomic shocks played a smaller role.
2) An unexpected reduction in bank capital can significantly impact the real economy, especially investment.
3) Financial frictions amplify monetary policy effects,
This document provides an overview of a master's thesis that investigates the influence of shadow banking activity on real economic growth. The thesis uses a multivariate regression analysis with GDP growth as the dependent variable and shadow banking leverage growth as the main independent variable, along with several control variables. The results of the regression analysis do not confirm the hypothesis that shadow banking activity positively impacts economic growth. Specifically, the coefficient for the shadow banking proxy is found to be significantly negative. However, robustness tests show that this sign and significance do not hold firmly. Therefore, the data cannot clearly establish a significant relationship between shadow banking activity and real growth.
Impact analysis of interest rate on the net assets of multinational businesse...Alexander Decker
This document summarizes a research study that examined the impact of interest rates on the net assets of multinational businesses in Nigeria from 1995 to 2010. A regression model was used to analyze the relationship between net asset value index and interest rates based on financial data from 7 randomly sampled multinational companies. The regression analysis showed that increases in interest rates resulted in reductions in net assets. Therefore, interest rates provide important information for multinational companies about profitability and maintaining the right debt-equity mix to remain competitive.
Aitor Erce's discussion of "The Seniority Structure of Sovereign Debt"ADEMU_Project
- The paper presents two new datasets on sovereign debt: one on payment arrears by sovereign debtors to different creditor groups, and one on haircuts applied in sovereign debt restructurings to private and official creditors.
- Analyzing the datasets, the paper finds a clear pecking order among creditors, with multilateral institutions, bonds, bilateral loans, banks, and suppliers at the bottom in terms of seniority.
- The main policy conclusion is that the official sector should reconsider its approach to debt restructuring, as the analysis shows official creditors have become increasingly junior over time.
This document summarizes a research paper that examines how financial distress affects the cross-section of equity returns. The paper develops a simple model that considers financial leverage in equity valuation and the potential for shareholder recovery during financial distress. The model shows that the possibility of shareholder recovery can reduce equity risk for highly distressed stocks. This helps explain various empirical patterns, such as lower returns for distressed stocks, stronger value effects for high default risk firms, and momentum profits concentrated in low credit quality stocks. The model predicts a hump-shaped relationship between value premiums and default probability, as well as stronger momentum profits for nearly distressed firms with higher potential recovery. Empirical tests on market data generally confirm these predictions.
COMPLEMENTARY CURRENCY AND ITS IMPACT ON THE ECONOMYIFLab
This document analyzes the potential impact of complementary currencies on a national economy. It begins by discussing how money is created in traditional capitalist economies through a two-stage process of central banks issuing debt and commercial banks providing loans. It then presents a system dynamics model to describe money issuance in economies with and without "inside money". As an example, it analyzes outcomes of a barter network in El Salvador and calculates spending multipliers. The main finding is that digital community currencies have greater spending multipliers than regular money markets. While the analyzed network is currently small, it could help cushion macroeconomic shocks by stabilizing aggregate demand.
This document summarizes a research paper that develops a dynamic general equilibrium model to analyze systemic risk in the banking sector. The key aspects of the model are that it includes banks that engage in maturity transformation by issuing non-state contingent debt, and the banks are exposed to risks in capital markets that can affect their solvency. The model shows that individual banks in a competitive system will take on excessive systemic risk due to pecuniary externalities, leading to a higher crisis probability than the socially optimal level. The document then discusses using prompt corrective action (PCA) policies to reduce crisis risk by strengthening bank capital requirements.
Does Liquidity Masquerade As Size FinalAshok_Abbott
he empirical results presented in this paper suggest a strong role for liquidity in explaining higher raw and excess returns realized by investors in less liquid stocks. Size effect has been studied extensively and it has been suggested that it may be a proxy for another unobserved factor. Our results strongly suggest that liquidity may be that unobserved factor explaining a large part but not all of the size premium.
This paper introduces an imperfectly competitive banking sector into a DSGE model to study the role of credit supply factors in business cycle fluctuations in the euro area. Banks issue loans to households and firms, obtain funding via deposits, and accumulate capital from retained earnings. Margins on loans depend on bank capital ratios and interest rate stickiness. Estimating the model with euro area data from 1999-2008, the paper finds that:
1) Shocks originating in the banking sector explain most of the output fall in 2008, while macroeconomic shocks played a smaller role.
2) An unexpected reduction in bank capital can significantly impact the real economy, especially investment.
3) Financial frictions amplify monetary policy effects,
This document provides an overview of a master's thesis that investigates the influence of shadow banking activity on real economic growth. The thesis uses a multivariate regression analysis with GDP growth as the dependent variable and shadow banking leverage growth as the main independent variable, along with several control variables. The results of the regression analysis do not confirm the hypothesis that shadow banking activity positively impacts economic growth. Specifically, the coefficient for the shadow banking proxy is found to be significantly negative. However, robustness tests show that this sign and significance do not hold firmly. Therefore, the data cannot clearly establish a significant relationship between shadow banking activity and real growth.
Impact analysis of interest rate on the net assets of multinational businesse...Alexander Decker
This document summarizes a research study that examined the impact of interest rates on the net assets of multinational businesses in Nigeria from 1995 to 2010. A regression model was used to analyze the relationship between net asset value index and interest rates based on financial data from 7 randomly sampled multinational companies. The regression analysis showed that increases in interest rates resulted in reductions in net assets. Therefore, interest rates provide important information for multinational companies about profitability and maintaining the right debt-equity mix to remain competitive.
Aitor Erce's discussion of "The Seniority Structure of Sovereign Debt"ADEMU_Project
- The paper presents two new datasets on sovereign debt: one on payment arrears by sovereign debtors to different creditor groups, and one on haircuts applied in sovereign debt restructurings to private and official creditors.
- Analyzing the datasets, the paper finds a clear pecking order among creditors, with multilateral institutions, bonds, bilateral loans, banks, and suppliers at the bottom in terms of seniority.
- The main policy conclusion is that the official sector should reconsider its approach to debt restructuring, as the analysis shows official creditors have become increasingly junior over time.
This thesis explores using econometric time series models to construct actively managed commodity portfolios. It reviews literature on commodities as an asset class and their benefits for diversification and inflation hedging. The document outlines momentum and term structure strategies, and introduces autoregressive, moving average, heteroskedasticity, and model averaging models to generate signals for a double sort methodology to improve risk-adjusted returns compared to naive momentum. Empirical results will be presented for full sample and pre/post crisis periods.
Fund flow volatility and performance rakowskibfmresearch
This paper analyzes the impact of daily mutual fund flow volatility on fund performance. The author finds that higher daily flow volatility is negatively associated with risk-adjusted fund performance. This relationship is strongest for domestic equity funds, smaller funds, better performing funds, and those that experienced net inflows. The results suggest daily fund flows impose liquidity costs through unnecessary trading that reduces returns.
Exchange rate volatility implied from option pricesSrdjan Begovic
This document is a dissertation submitted by Srdjan Begovic in partial fulfillment of a Master's degree in finance and investments from Aston University. The dissertation focuses on forecasting exchange rate volatility using three models: GARCH(1,1), Black-Scholes implied volatility, and model-free implied volatility. Forecasts from these three models are generated for the out-of-sample period from January 2002 to December 2006 using weekly data on seven exchange rates. The forecasts are then evaluated and compared based on accuracy measures to determine the most reliable model for predicting realized volatility.
STRESS TESTING IN BANKING SECTOR FRAMEWORKDinabandhu Bag
This document summarizes a study analyzing default correlation in retail banking portfolios in India. It discusses:
1) Literature on default correlation and factor modeling approaches to estimate correlation. Previous studies found correlation varies over time and across industries/ratings.
2) Analysis of a test portfolio with 4 retail segments showing migration of exposures between segments over 14 months. Segments showed varying default rate trends over time.
3) The study builds a multi-factor linear model to test if external economic factors significantly impact default correlations between segments over time.
The main motivation of this study is to investigate the relationship between indicator of financial development and individual’s daily decision regarding their final consumption and saving in a selected sample of middle east and north African (MENA) countries. The method which used for this analysis is pooled regression and the data collected from ten different countries (Qatar, Jordon, Oman, Turkey, Armenia, Azerbaijan, United Arab Emirates, Saudi Arabia, Bahrain, Pakistan) during 1995 and 2015. Finally, by analyzing the Stata results it will be clear that which variable has positive effect on the share of final consumption expenditure in GDP and which one has the negative effect and the significant and insignificant of these effects.
Juan Carlos Hatchondo's discussion of "Self-Fulfilling Debt Restructuring"ADEMU_Project
This document discusses a model of self-fulfilling debt restructuring where larger haircuts during debt settlements are associated with higher post-settlement bond spreads. The model incorporates coordination failures among lenders that can lead to either a "good" equilibrium with lending or a "bad" equilibrium with default. Larger haircuts occur after settlements in times of the bad equilibrium, leading bondholders to view higher haircuts as a negative signal about future repayment, which then feeds back to higher post-settlement spreads. The model aims to understand the link between haircuts, spreads, and measures of global risk premiums.
Adding listed real estate to an unlisted portfolio what are the risk and ret...Consiliacapital
Adding listed real estate to an unlisted real estate portfolio can enhance returns while providing increased liquidity. Analyzing UK unlisted and global listed real estate fund data from 2003-2013, the study found:
1) Adding a 30% weighting to listed real estate would have increased absolute returns of the unlisted portfolio by 30% over 10 years and by 22% during a period of rising property values.
2) During the global financial crisis, including a 30% listed weighting led to only a marginal 2.2% decrease in returns, representing a small cost compared to the increased liquidity.
3) Breaking the period into different market conditions, the addition of listed real estate consistently enhanced returns except during
Manual for calculating adjusted net savingsIntrosust
Lea hasta la página 7 (aunque se le recomienda leer el documento completo).
Actividad:
¿Por qué es el ahorro ajustado neto una mejora respecto a los cálculos estándar de ahorro neto?
This document reviews research on the relationship between investor sentiment and stock market fluctuations. It discusses how investor sentiment can influence irrational investor behavior, though efficient market theory says stock prices fully reflect all public information. Several studies find connections between sentiment indices and stock returns, though sentiment is not a purely "financial" factor and can be driven by human psychology. The conclusion suggests incorporating sentiment into stock valuation to help analyze portfolios, while noting sentiment cannot predict events like the 2008 recession and emphasizing the need to understand how psychological factors influence human behavior and the market.
Mitigating the Deadly Embrace in Financial Cycles: Countercyclical Buffers an...Joannes Mongardini
IMF Working Paper WP/16/87 providing macroprudential simulations of the effectiveness of countercyclical buffers and loan-to-value limits to mitigate housing bubbles and bursts
Why Emerging Managers Now? - Infusion Global Partners WhitepaperAndrei Filippov
Traditional asset classes appear to offer uninspiring beta returns at present, and recent years’ hedge fund returns have disappointed both in magnitude and diversification benefits, likely reflecting capacity pressures associated with the concentration of AUM and inflows with larger funds. We argue that, by contrast, Emerging hedge funds offer a rich opportunity set with far fewer capacity issues where skilled managers with concrete competitive advantages in less efficient, smaller capitalization market segments can generate better, more sustainable and less correlated excess returns. Emerging managers do involve more investment and operational risk than larger peers; to that challenge we offer some suggestions on a thoughtful and rigorous approach to constructing an Emerging Managers allocation and balancing effective due diligence with scalability.
Macroeconomic and industry determinants of interest rate spread empirical evi...Alexander Decker
This document summarizes a study that examines the bank-specific, industry-specific, and macroeconomic factors that influence interest rate spreads in Ghanaian commercial banks from 1990 to 2010. The study uses data from 33 commercial banks over this 21-year period. Key findings include that interest rate spreads are significantly influenced by bank ownership, management efficiency, GDP per capita, and government securities. Government borrowing also influences spreads but has a negative effect. The paper aims to identify important determinants of interest rate spreads for central banks, commercial banks, and economic managers in Ghana.
The causal relationship between exchange rates and stock prices in kenyaAlexander Decker
This study examines the causal relationship between exchange rates and stock prices in Kenya from 1993 to 1999. The empirical results show that exchange rates and stock prices are nonstationary and integrated of order one. Tests also show that the two variables are cointegrated. Error-correction models were used instead of Granger causality tests due to the cointegration. The empirical results indicate that exchange rates Granger-cause stock prices in Kenya, meaning that changes in exchange rates lead to changes in stock prices.
Abstract The main purpose of this paper is to investigate whether stock prices and exchange rates are related to each
other or not. Both the short term and the long term association between these variables are discovered. The study applies
monthly and quarterly data on two gulf countries, including Kingdom Saudi Arabia (KSA) and United Arab Emirate (UAE)
for the period January 2008 to December 2009. The results of this study in the short term found that the exchange rate
influence positively on the stock market price index for United Arab Emirate and there is no association between them for
Kingdom Saudi Arabia. Moreover the study in the long term found that the exchange rate influence negatively on stock
market price index for the United Arab Emirate. While no association between these variables in Kingdom Saudi Arabia.
Ramon Marimon's discussion of "Self-fulfilling Debt Crises, Revisited: The A...ADEMU_Project
This document summarizes Ramon Marimon's discussion of the paper "Self-Fulfilling Debt Crises, Revisited: The Art of the Desperate Deal" by Mark Aguiar, Satyajit Chatterjee, Harold Cole and Zachary Stangebye (ACCS). The summary outlines five key points: 1) ACCS builds substantially on previous work by Chatterjee and Koch (CK) beyond just introducing "Desperate Deals", 2) sunspot equilibria may not be learnable but sovereign bond auctions provide information, 3) the paper could eliminate its use of sunspots, 4) "Desperate Deals" may have greater value than claimed,
This bachelor thesis examines the key determinants of shadow banking systems in the Euro area, United Kingdom, and United States. The author builds a measure of shadow banking from a European perspective and analyzes the relationship between the shadow banking measure and several macroeconomic and financial variables. Regression analysis is conducted on two models - a base model including GDP, institutional investor assets, term spread, bank net interest margin, and liquidity, and an extended model which adds a systemic stress indicator, banking concentration index, and inflation. The analysis finds significant geographical differences in the relationships between shadow banking and the explanatory variables within the Euro area. Specifically, for some countries shadow banking grows as GDP, term spread, and liquidity increase, while for other countries
This document summarizes a working paper that examines the statistical properties of current account balances and their determinants across 70 countries. It finds that once regime shifts are allowed for using Markov-switching models, the null hypothesis of a unit root can be rejected for more countries than with standard linear unit root tests. The paper also investigates what country characteristics, such as exchange rate regimes, financial openness, and macroeconomic fundamentals, help explain differences in the likelihood of entering non-stationary current account regimes and in the degree of current account persistence across regimes.
Disparity in growth rates among countriesSparsh Banga
The document analyzes convergence between countries using GDP data from 1995-2014 for 30 countries grouped into developed, developing, and least developed. Section 1 finds the growth rates for each country over time. Section 2 calculates the coefficient of variation to measure sigma convergence, regressing it on time. Section 3 measures beta convergence by regressing countries' growth rates on their initial GDP, testing if poorer countries grew faster. The results show developing countries like India and China grew around 10-15%, least developed countries around 8-17%, and developed countries around 3-5%, indicating some degree of conditional convergence between income groups.
This document provides an agenda and overview of key concepts for a session on exchange rate determination and forecasting. The session will cover:
1) International parity relations like purchasing power parity and interest rate parity
2) Determinants of exchange rates in the short and long run, including factors like inflation rates, interest rates, economic performance, and monetary/fiscal policy
3) Different exchange rate regimes including floating, fixed, pegged, and currency boards
4) Methodologies and models for exchange rate forecasting, including econometric and technical analysis approaches
This document provides estimates for the total value of global assets across various categories. It estimates the following total values:
- Public equity: $67 trillion
- Fixed income: $100 trillion
- Property: $95 trillion
- State-owned enterprises: $35 trillion
- Privately owned companies: $4 trillion
- Infrastructure: $35 trillion
- Real assets: $10 trillion
It argues that obtaining an accurate total "Value of Everything" is important for understanding the global financial system and influencing sustainable development.
This document provides an overview of the oil market in March 2009. It discusses the relative stability of crude oil prices despite continued economic uncertainties and downward revisions to oil demand forecasts. Global oil demand is expected to decline by 1.0 mb/d in 2009, with OECD seeing a decline of 1.3 mb/d. Non-OPEC supply is projected to increase by 0.4 mb/d in 2009. Required OPEC crude is projected to decrease by 1.8 mb/d in 2009 compared to 2008. The document also discusses movements in the OPEC Reference Basket price in February 2009 and issues to be considered at the upcoming OPEC conference.
The 1990’s financial crises in Nordic countriesPeter Ho
The 1990s financial crises in the Nordic countries impacted Finland, Norway, and Sweden. All three countries experienced rapid growth and lending in the 1980s that led to overheating and current account deficits. This was followed by deep recessions in the early 1990s as asset and housing prices collapsed, unemployment rose, and banks faced huge losses. Finland's crisis was the most severe, with over 10% cumulative GDP decline. Public authorities had to provide significant support to stabilize the banking systems. The crises highlighted the risks of financial deregulation and overheating from excessive lending and asset price booms.
This thesis explores using econometric time series models to construct actively managed commodity portfolios. It reviews literature on commodities as an asset class and their benefits for diversification and inflation hedging. The document outlines momentum and term structure strategies, and introduces autoregressive, moving average, heteroskedasticity, and model averaging models to generate signals for a double sort methodology to improve risk-adjusted returns compared to naive momentum. Empirical results will be presented for full sample and pre/post crisis periods.
Fund flow volatility and performance rakowskibfmresearch
This paper analyzes the impact of daily mutual fund flow volatility on fund performance. The author finds that higher daily flow volatility is negatively associated with risk-adjusted fund performance. This relationship is strongest for domestic equity funds, smaller funds, better performing funds, and those that experienced net inflows. The results suggest daily fund flows impose liquidity costs through unnecessary trading that reduces returns.
Exchange rate volatility implied from option pricesSrdjan Begovic
This document is a dissertation submitted by Srdjan Begovic in partial fulfillment of a Master's degree in finance and investments from Aston University. The dissertation focuses on forecasting exchange rate volatility using three models: GARCH(1,1), Black-Scholes implied volatility, and model-free implied volatility. Forecasts from these three models are generated for the out-of-sample period from January 2002 to December 2006 using weekly data on seven exchange rates. The forecasts are then evaluated and compared based on accuracy measures to determine the most reliable model for predicting realized volatility.
STRESS TESTING IN BANKING SECTOR FRAMEWORKDinabandhu Bag
This document summarizes a study analyzing default correlation in retail banking portfolios in India. It discusses:
1) Literature on default correlation and factor modeling approaches to estimate correlation. Previous studies found correlation varies over time and across industries/ratings.
2) Analysis of a test portfolio with 4 retail segments showing migration of exposures between segments over 14 months. Segments showed varying default rate trends over time.
3) The study builds a multi-factor linear model to test if external economic factors significantly impact default correlations between segments over time.
The main motivation of this study is to investigate the relationship between indicator of financial development and individual’s daily decision regarding their final consumption and saving in a selected sample of middle east and north African (MENA) countries. The method which used for this analysis is pooled regression and the data collected from ten different countries (Qatar, Jordon, Oman, Turkey, Armenia, Azerbaijan, United Arab Emirates, Saudi Arabia, Bahrain, Pakistan) during 1995 and 2015. Finally, by analyzing the Stata results it will be clear that which variable has positive effect on the share of final consumption expenditure in GDP and which one has the negative effect and the significant and insignificant of these effects.
Juan Carlos Hatchondo's discussion of "Self-Fulfilling Debt Restructuring"ADEMU_Project
This document discusses a model of self-fulfilling debt restructuring where larger haircuts during debt settlements are associated with higher post-settlement bond spreads. The model incorporates coordination failures among lenders that can lead to either a "good" equilibrium with lending or a "bad" equilibrium with default. Larger haircuts occur after settlements in times of the bad equilibrium, leading bondholders to view higher haircuts as a negative signal about future repayment, which then feeds back to higher post-settlement spreads. The model aims to understand the link between haircuts, spreads, and measures of global risk premiums.
Adding listed real estate to an unlisted portfolio what are the risk and ret...Consiliacapital
Adding listed real estate to an unlisted real estate portfolio can enhance returns while providing increased liquidity. Analyzing UK unlisted and global listed real estate fund data from 2003-2013, the study found:
1) Adding a 30% weighting to listed real estate would have increased absolute returns of the unlisted portfolio by 30% over 10 years and by 22% during a period of rising property values.
2) During the global financial crisis, including a 30% listed weighting led to only a marginal 2.2% decrease in returns, representing a small cost compared to the increased liquidity.
3) Breaking the period into different market conditions, the addition of listed real estate consistently enhanced returns except during
Manual for calculating adjusted net savingsIntrosust
Lea hasta la página 7 (aunque se le recomienda leer el documento completo).
Actividad:
¿Por qué es el ahorro ajustado neto una mejora respecto a los cálculos estándar de ahorro neto?
This document reviews research on the relationship between investor sentiment and stock market fluctuations. It discusses how investor sentiment can influence irrational investor behavior, though efficient market theory says stock prices fully reflect all public information. Several studies find connections between sentiment indices and stock returns, though sentiment is not a purely "financial" factor and can be driven by human psychology. The conclusion suggests incorporating sentiment into stock valuation to help analyze portfolios, while noting sentiment cannot predict events like the 2008 recession and emphasizing the need to understand how psychological factors influence human behavior and the market.
Mitigating the Deadly Embrace in Financial Cycles: Countercyclical Buffers an...Joannes Mongardini
IMF Working Paper WP/16/87 providing macroprudential simulations of the effectiveness of countercyclical buffers and loan-to-value limits to mitigate housing bubbles and bursts
Why Emerging Managers Now? - Infusion Global Partners WhitepaperAndrei Filippov
Traditional asset classes appear to offer uninspiring beta returns at present, and recent years’ hedge fund returns have disappointed both in magnitude and diversification benefits, likely reflecting capacity pressures associated with the concentration of AUM and inflows with larger funds. We argue that, by contrast, Emerging hedge funds offer a rich opportunity set with far fewer capacity issues where skilled managers with concrete competitive advantages in less efficient, smaller capitalization market segments can generate better, more sustainable and less correlated excess returns. Emerging managers do involve more investment and operational risk than larger peers; to that challenge we offer some suggestions on a thoughtful and rigorous approach to constructing an Emerging Managers allocation and balancing effective due diligence with scalability.
Macroeconomic and industry determinants of interest rate spread empirical evi...Alexander Decker
This document summarizes a study that examines the bank-specific, industry-specific, and macroeconomic factors that influence interest rate spreads in Ghanaian commercial banks from 1990 to 2010. The study uses data from 33 commercial banks over this 21-year period. Key findings include that interest rate spreads are significantly influenced by bank ownership, management efficiency, GDP per capita, and government securities. Government borrowing also influences spreads but has a negative effect. The paper aims to identify important determinants of interest rate spreads for central banks, commercial banks, and economic managers in Ghana.
The causal relationship between exchange rates and stock prices in kenyaAlexander Decker
This study examines the causal relationship between exchange rates and stock prices in Kenya from 1993 to 1999. The empirical results show that exchange rates and stock prices are nonstationary and integrated of order one. Tests also show that the two variables are cointegrated. Error-correction models were used instead of Granger causality tests due to the cointegration. The empirical results indicate that exchange rates Granger-cause stock prices in Kenya, meaning that changes in exchange rates lead to changes in stock prices.
Abstract The main purpose of this paper is to investigate whether stock prices and exchange rates are related to each
other or not. Both the short term and the long term association between these variables are discovered. The study applies
monthly and quarterly data on two gulf countries, including Kingdom Saudi Arabia (KSA) and United Arab Emirate (UAE)
for the period January 2008 to December 2009. The results of this study in the short term found that the exchange rate
influence positively on the stock market price index for United Arab Emirate and there is no association between them for
Kingdom Saudi Arabia. Moreover the study in the long term found that the exchange rate influence negatively on stock
market price index for the United Arab Emirate. While no association between these variables in Kingdom Saudi Arabia.
Ramon Marimon's discussion of "Self-fulfilling Debt Crises, Revisited: The A...ADEMU_Project
This document summarizes Ramon Marimon's discussion of the paper "Self-Fulfilling Debt Crises, Revisited: The Art of the Desperate Deal" by Mark Aguiar, Satyajit Chatterjee, Harold Cole and Zachary Stangebye (ACCS). The summary outlines five key points: 1) ACCS builds substantially on previous work by Chatterjee and Koch (CK) beyond just introducing "Desperate Deals", 2) sunspot equilibria may not be learnable but sovereign bond auctions provide information, 3) the paper could eliminate its use of sunspots, 4) "Desperate Deals" may have greater value than claimed,
This bachelor thesis examines the key determinants of shadow banking systems in the Euro area, United Kingdom, and United States. The author builds a measure of shadow banking from a European perspective and analyzes the relationship between the shadow banking measure and several macroeconomic and financial variables. Regression analysis is conducted on two models - a base model including GDP, institutional investor assets, term spread, bank net interest margin, and liquidity, and an extended model which adds a systemic stress indicator, banking concentration index, and inflation. The analysis finds significant geographical differences in the relationships between shadow banking and the explanatory variables within the Euro area. Specifically, for some countries shadow banking grows as GDP, term spread, and liquidity increase, while for other countries
This document summarizes a working paper that examines the statistical properties of current account balances and their determinants across 70 countries. It finds that once regime shifts are allowed for using Markov-switching models, the null hypothesis of a unit root can be rejected for more countries than with standard linear unit root tests. The paper also investigates what country characteristics, such as exchange rate regimes, financial openness, and macroeconomic fundamentals, help explain differences in the likelihood of entering non-stationary current account regimes and in the degree of current account persistence across regimes.
Disparity in growth rates among countriesSparsh Banga
The document analyzes convergence between countries using GDP data from 1995-2014 for 30 countries grouped into developed, developing, and least developed. Section 1 finds the growth rates for each country over time. Section 2 calculates the coefficient of variation to measure sigma convergence, regressing it on time. Section 3 measures beta convergence by regressing countries' growth rates on their initial GDP, testing if poorer countries grew faster. The results show developing countries like India and China grew around 10-15%, least developed countries around 8-17%, and developed countries around 3-5%, indicating some degree of conditional convergence between income groups.
This document provides an agenda and overview of key concepts for a session on exchange rate determination and forecasting. The session will cover:
1) International parity relations like purchasing power parity and interest rate parity
2) Determinants of exchange rates in the short and long run, including factors like inflation rates, interest rates, economic performance, and monetary/fiscal policy
3) Different exchange rate regimes including floating, fixed, pegged, and currency boards
4) Methodologies and models for exchange rate forecasting, including econometric and technical analysis approaches
This document provides estimates for the total value of global assets across various categories. It estimates the following total values:
- Public equity: $67 trillion
- Fixed income: $100 trillion
- Property: $95 trillion
- State-owned enterprises: $35 trillion
- Privately owned companies: $4 trillion
- Infrastructure: $35 trillion
- Real assets: $10 trillion
It argues that obtaining an accurate total "Value of Everything" is important for understanding the global financial system and influencing sustainable development.
This document provides an overview of the oil market in March 2009. It discusses the relative stability of crude oil prices despite continued economic uncertainties and downward revisions to oil demand forecasts. Global oil demand is expected to decline by 1.0 mb/d in 2009, with OECD seeing a decline of 1.3 mb/d. Non-OPEC supply is projected to increase by 0.4 mb/d in 2009. Required OPEC crude is projected to decrease by 1.8 mb/d in 2009 compared to 2008. The document also discusses movements in the OPEC Reference Basket price in February 2009 and issues to be considered at the upcoming OPEC conference.
The 1990’s financial crises in Nordic countriesPeter Ho
The 1990s financial crises in the Nordic countries impacted Finland, Norway, and Sweden. All three countries experienced rapid growth and lending in the 1980s that led to overheating and current account deficits. This was followed by deep recessions in the early 1990s as asset and housing prices collapsed, unemployment rose, and banks faced huge losses. Finland's crisis was the most severe, with over 10% cumulative GDP decline. Public authorities had to provide significant support to stabilize the banking systems. The crises highlighted the risks of financial deregulation and overheating from excessive lending and asset price booms.
The document provides one-page summaries of responses from 43 state Medicaid Directors and Washington D.C. on the impact of 7 recent Medicaid regulations. For each state, the summaries include estimates of lost federal funds in 2008 and over 5 years for regulations limiting payments to public providers, graduate medical education, outpatient hospital services, provider taxes, coverage of rehabilitative services, payments for school services, and targeted case management. Quotes from each state convey concerns about reduced access to care, loss of providers and services, and increased costs.
The document discusses the bankruptcy discharge process. It explains that:
1) A bankruptcy discharge releases debtors from personal liability for certain debts and prohibits creditors from collecting on those debts. However, valid liens remain enforceable.
2) The timing of discharge varies by chapter, but generally occurs 4 months after filing for chapter 7 and after completing all payments under chapter 12 or 13 plans, which usually takes 3-5 years.
3) Not all debts are discharged - there are several categories of debt that are exempt from discharge for public policy reasons, such as certain taxes, debts from fraud or willful/malicious behavior, and student loans. Creditors must object to the discharge of other specified debts.
The document provides an overview and analysis of China's economic developments in the first half of 2009. It discusses three main points:
1) While China's economy has continued to feel the effects of the global crisis, very expansionary fiscal and monetary policies have supported growth. Government investment has soared while market investment has lagged. Consumption has held up well.
2) Exports remain very weak but imports have recovered as stimulus has boosted demand for raw materials. GDP growth was a respectable 6% in the first quarter.
3) Downward pressure on inflation has continued as falling raw material prices drag down prices, but overcapacity is squeezing industry profits. Growth is projected to remain around 7%
The State of Public Finances: A Cross-Country Fiscal MonitorPeter Ho
The global fiscal response to the crisis has been sizable but implementation has been uneven. Among G-20 countries, fiscal deficits are projected to increase by 5.5% of GDP in both 2009 and 2010 due to discretionary stimulus measures, automatic stabilizers, and falling revenues. Tax cuts have been implemented more quickly than spending measures. While a comprehensive assessment is difficult due to limited reporting, signs indicate the pace of stimulus spending has accelerated recently in some countries like the US. Overall, fiscal expansion has helped counter the economic downturn but medium-term fiscal strategies are still lacking in many countries.
Lessons of the Financial Crisis for Future Regulation of Financial InstitutionsPeter Ho
The document summarizes lessons learned from the ongoing financial crisis for future regulation of financial institutions and markets. Key points include:
- The crisis exposed inadequacies in regulation, supervision, and risk management that failed to prevent excessive risk-taking. Reform is needed to address these issues.
- Priorities for reform include expanding regulation to new entities, addressing procyclicality of capital requirements, improving information sharing, resolving cross-border regulatory issues, and strengthening central bank liquidity management.
- International bodies like the FSF and G20 working groups are examining these issues and developing policy recommendations, but more work is still needed to implement reforms.
The document provides an overview and analysis of the global economic outlook by the IMF staff. It finds that:
1) Global economic activity has fallen sharply, with advanced economies experiencing their worst declines since World War 2.
2) The IMF forecasts that the global economy will contract by 0.5-1% in 2009 on average before a gradual recovery in 2010.
3) Turning the global economy around depends critically on concerted policy actions to stabilize financial conditions and support demand through fiscal and monetary policies.
This document summarizes a paper that analyzes whether central banks should modify their interest rate policy rules (like the Taylor rule) to account for credit spreads or credit volumes. The paper uses a New Keynesian economic model modified to include financial frictions like heterogeneous households and credit markets. It finds that adjusting the policy rate in response to changes in credit spreads or volumes can improve outcomes in response to financial disturbances, but such adjustments may not help or could hurt in response to other disturbance types. The paper concludes by discussing the model and outlining the analysis that will be conducted using the model to evaluate modified policy rules.
1) The document examines how central banks balance inflation/output targets with costly sterilization of capital inflows. When sterilization costs rise, central banks limit sterilization, allowing exchange rates to adjust.
2) Empirical tests on developing countries from 1984-1992 confirm monetary policy responds to higher sterilization costs by allowing greater exchange rate changes. However, other model predictions have mixed results depending on how endogeneity is treated.
3) A theoretical model shows that higher sterilization costs are incorporated into central bank decisions as they impact the consolidated public sector budget constraint. This leads central banks to limit sterilization and tolerate more exchange rate movement.
This paper integrates agency costs into a standard Dynamic New Keynesian model in a transparent way. Agency costs are modeled as a collateral constraint on entrepreneurial hiring of labor based on net worth. Three key results are:
1) Agency costs act as endogenous markup shocks in the Phillips curve.
2) The model welfare function includes a measure of credit market tightness interpreted as a risk premium.
3) Optimal monetary policy can be characterized as an inflation targeting rule, but it may optimally deviate from strict inflation stabilization in response to financial shocks.
This paper presents a model to value cash holdings for all-equity financed firms with growth opportunities. The model considers the tradeoff between agency costs of free cash flow and costs of external financing. It derives the optimal dynamic cash retention policy and shows that firms optimally retain only a fraction of cash flows. The model implies that high cash flow volatility decreases the value of cash and that optimal cash retention can delay investment timing. Empirical tests on US firm data from 1980-2010 confirm these implications, finding a negative relationship between cash value and volatility in the context of growth options.
The paper re-assesses the impact of exchange rate regimes on macroeconomic performance. We test for the relationship between de jure and de facto exchange rate classifications on the one hand, and inflation, output growth and output volatility on the other. We find that, once high-inflation outliers are excluded from the sample, only hard exchange rate pegs are associated with lower inflation compared to the floating regime. There is no significant relationship between output growth and exchange rate regimes, confirming results from previous studies. De jure pegged regimes (broadly defined) are correlated with higher output volatility, but this relationship is reversed for the de facto classification. The last result points to a potential endogeneity problem present when the de facto classification is used in testing for the relationship between exchange rate behavior and macroeconomic performance.
Authored by: Maryla Maliszewska, Wojciech Maliszewski
Published in 2004
Liquidity Risk and Expected Stock Returns Lubos Pastor and Robert F- S.docxLucasmHKChapmant
Liquidity Risk and Expected Stock Returns Lubos Pastor and Robert F. Stambaugh NBER Working Paper No. 8462 September 2001 JEL No. G12 ABSTRACT This study investigates whether market-wide liquidity is a state variable important for asset pricing. We find that expected stock returns are related cross-sectionally to the sensitivities of returns to fluctuations in aggregate liquidity. Our monthly liquidity measure, an average of individual-stock measures estimated with daily data, relies on the principle that order flow induces greater return reversals when liquidity is lower. Over a 34-year period, the average retum on stocks with high sensitivities to liquidity exceeds that for stocks with low sensitivities by 7.5% annually, adjusted for exposures to the market return as well as size, value, and momentum factors. 1. Introduction In standard asset pricing theory, expected stock returns are related cross-sectionally to returns' senxitivities to state variables with pervasive effects on consumption and invertment opportunities. The basic intuition is that a security whose lowest returns tend to accompany unfavorable shifts in quantities afferting an imvestor's overall welfare must offer additional compensation to the investor for holding that security. Liquidity appears to be a good candidate for a priced state variable. It is often viewed as important for investment decisions, and recent studies find that fluctuations in various measures of liquidity are correlated acroos stocks." This empirical study investigates whether market-wide liquidity is indeed priced. That is, we ask whether cross-sectional differences in expected stock returns are rehated to the sensitivities of returns to fluctuations in aggregate liquidity. 2 Liquidity is a broad and elusive concept that generally denotes the ability to trade large quantities quickly, at low cost, and without moving the price. We focus on an aspect of liquidity associated with temporary price fluctuations induced by order flow. Our monthly aggregate liquidity measure is a cross-sectional average of individual-stock liquidity measures. Each stock's liquidity in a given month, etimated using that stock's within-month daily returns and volume, represents the average effect that a given volume on day d has on the return for day d + 1 , when the volume is given the same sign as the return on day d . The basic idea is that, if signed volume is viewed ronghly as "order flow," then lower liquidity is reflected in a greater tendency for order flow in a given direction on day d to be followed by a price change in the opposite direction on day d + 1 . Esentially, lower liquidity corresponds to stronger volume-related return reversals, and in this respect our liquidity measure follows the same line of reasoning as the model and empirical evidence presented by Campbell, Groseman, and Wang (1993). They find that sturns accompanied by high volume tend to be reversed more strongly, and they explain how this result i.
Article 1Authors Christian Ewerhart, Nuno Cassola, Steen Ejersk.docxfredharris32
Article 1
Authors: Christian Ewerhart, Nuno Cassola, Steen Ejerskov, Natacha Valla
Title of the article: Manipulation in money markets
Journal Name: International Journal of Central Banking, March 2007
Summary
The article talks about the impact of manipulation in the implementation of the monetary policy. The authors claim that as a result of the impulsive reactions to the fundamental index of interbank interest rates, manipulation has turned out to be a major challenge for the operational enactment of the monetary policy. Therefore, to address the issue, the authors have focused on a microstructure model whereby a commercial bank can have a strategic alternative to the standing facilities of the central bank. They typify equilibrium where market rates are positively manipulated. The findings of the study prove that manipulation can be lucrative for a commercial bank with appropriate ex-ante features. And so, manipulation will continue to be a characteristic of equilibrium albeit stakeholders in the derivatives market create rational prospects regarding potential manipulation. The authors conclude by recognizing that the monetary authority has controlling techniques to fight manipulation and that further vigilance is required to ascertain that there is no operational manipulation (Ewerhart, Cassola, Ejerskov, & Valla, 2007).
Key points
The principal ideas discussed in the article regarding manipulation in the money markets include:
· Manipulation is a potential concern in money markets, particularly when a commercial bank holds a profitable position in which it can gain from may be an increase in interest rates.
· From an operational viewpoint, manipulation can increase volatility to the immediate interest rate thereby complicating the liquidity control of both the central bank and the commercial banks.
· Manipulation can have an impact on the market's confidence during a smooth execution of monetary policy, which will in turn affect the long-term refinancing conditions thereby upsetting the effectiveness of the monetary policy.
· The decision to manipulate a market by a commercial bank is contingent on factors such as the bank's general trading and deposit capacities, its readiness to take premeditated measures in search of profitable frontiers as well as the internal distribution of its risk budget between money markets.
· Competition amongst potential manipulators cannot impede the likelihood of manipulation.
· The immediate reaction by the central bank can help in reducing the volatility in the money markets caused by manipulations.
Reaction to the article
The microstructure model used in the study to show that manipulation can be lucrative for a commercial bank is efficient to illustrate the nature of financial markets. The model implies that investors can benefit from insider information and use it to change the nature of financial markets. In the financial stock market, insider information may lead to trading of stocks between invest ...
Determinants of interest rate empirical evidence from pakistanAlexander Decker
This document summarizes a research paper that analyzes the determinants of interest rates in Pakistan. It begins with background definitions of key rate indicators like KIBOR and inflation. It then states the purpose is to study the determinants of interest rates, with the hypotheses that inflation and exchange rates have a positive impact on interest rates. The literature review summarizes several past studies on factors influencing interest rates in countries like Pakistan, Austria, and Japan. These studies examined the relationship between policy rates, market rates, inflation, and economic growth.
The document summarizes a study that uses a structural vector autoregressive (SVAR) model to estimate the impact of unconventional monetary policy on macroeconomic variables in the UK. The study focuses on the bank lending channel as a possible transmission mechanism. The results from the baseline SVAR model show that unconventional monetary policy can generate inflation and increase output, but the effects are small and short-lived. However, the results are not robust for output based on sensitivity analysis. The study also does not find strong evidence that the bank lending channel is a significant transmission mechanism for unconventional monetary policy.
Investing in a Rising Rate Environment - Dec. 2011RobertWBaird
- Rising interest rates can negatively impact bond prices in the short-term but a focus on total return, which includes interest income, provides a more accurate picture of bond performance over time.
- An analysis of periods from 1994-2006 when the Federal Reserve raised rates found that while bond prices fell in the majority of months, interest income was positive every month and total returns were positive in 64% of months.
- Diversifying across different types of bonds can help mitigate the effects of rising rates as different bond segments perform variably depending on economic conditions. Professional bond managers employ strategies to offset negative impacts and maximize total returns.
07. the determinants of capital structurenguyenviet30
This document summarizes a research paper that investigates how firms in capital market-oriented economies (UK, US) and bank-oriented economies (France, Germany, Japan) determine their capital structures. Using panel data and regression analysis, the paper finds that firm size and tangibility of assets increase leverage, while profitability, growth opportunities, and share price performance decrease leverage in both types of economies. However, the impacts of some determinants vary between countries depending on differences in institutions and traditions. The paper also finds that firms have target leverage ratios but adjust to them at different speeds across countries.
Question 1Response 1Development inside and out effects t.docxaudeleypearl
Question 1:
Response 1:
Development inside and out effects the entire country's economy. It impacts the managing body, regardless the clearly irrelevant subtleties in the average person's dependably life. Both a conditions and clear deferred results of how the economy is getting along, swelling has the two its fans and spoilers. Distinctive envisions that particular degrees of swelling are helpful for a prospering economy, yet that progressively critical rates raise concerns. It can degrade the money basically and, at logically lamentable, has been a key part to subsidences.
Swelling, as referenced, is the rate a worth ascensions, and fundamentally how much the dollar is worth at a given moment concerning checking. The idea behind swelling being an impact for good in the economy is that a reasonable enough rate can nudge financial movement without debasing the money so much that it ends up being basically vain (Kohn, 2006).
Swelling can in like manner falter from asset for asset. Subordinate upon the season, the expense of gas could go up independently from with everything considered headway as it routinely does as summer moves close. In reality, there is even a term - focus improvement - for swelling that parts in everything except for sustenance and imperativeness (gas and oil), as these regions have separate factors that add to them. There are a wide degree of sorts of swelling, subordinate upon what remarkable is being viewed comparatively as what the development rate truly is by all accounts. For example, what happens if the swelling rate is well over the Fed's normal goal? At a higher rate, yet still in the single digits, that is known as walking swelling. It is seen as concerning yet sensible (Ball, 2006).
Swelling is generally depicted reliant on its rate and causes. By and large, Inflation happens in an economy when vitality for thing and experiences outmaneuvers the supply of yield. in this manner, clarifications behind Inflation have different sides, the intrigue side and supply side. The widely inclusive activity of hazard premiums in driving enlargement pay over the scope of advancing years is dependable with secured budgetary improvement and inside and out oblige cash related procedure events in the moved economies. The degree for further fitting budgetary enabling seen with money related stars seems to have declined amidst the enough low advance charges and gigantic monetary records of national banks (Bodie, 2016).
In relentless time, the correspondence of perils has wound up being constantly phenomenal, the general point of view has lit up, and money related conditions have engaged on net. With the work superstar proceeding to reinforce, and GDP improvement expected to keep up a vital good ways from back in the consequent quarter, it likely will be fitting soon to change the affiliation supports rate. Likewise, if the economy propels as shown by the SEP concentrate way, the affiliation supports rate will probably app ...
This document provides a study guide and analysis for a case study on determining the appropriate discount rate for cash flows in Venezuela for Telmex's potential acquisition of shares in CANTV.
The study guide outlines the teaching objectives of understanding challenges in estimating the cost of capital in emerging markets. It also reviews different methodologies that have been used to incorporate country risk into discount rate calculations, including modified versions of the CAPM model. The analyses of these methods note their advantages and disadvantages when the perception of sovereign risk differs from private sector risk, as it does in Venezuela.
The document concludes by providing a teaching plan to analyze financial information, review risk calculation theories, consider the dilemma of what discount rate to propose,
HOW DOES CHANGE IN RATE OF INTEREST AND INVESTMENT LEVEL AFFECT THE GOODS MAR...SHIV380128
- The document analyzes how changes in interest rates and investment levels affect goods and money markets using an IS-LM framework.
- It estimates equations for the real interest rate and GDP growth simultaneously using a two-stage least squares approach.
- The results indicate that real money balances have a negative influence on interest rates, while GDP growth has a positive influence. Investment expenditure positively influences GDP growth, while interest rate changes negatively influence GDP growth.
This document presents an estimated arbitrage-free model that jointly models nominal and real US Treasury yields. It estimates separate arbitrage-free Nelson-Siegel models for nominal and real yields, finding a three-factor model fits nominal yields well and a two-factor model fits real yields. It then estimates a four-factor joint model that fits both yield curves. The joint model is used to decompose breakeven inflation rates into inflation expectations and inflation risk premium components.
THE OPTIMAL LEVEL OF INTERNATIONAL RESERVES FOR EMERGING MARKET COUNTRIES: A ...Nicha Tatsaneeyapan
This document presents a model for determining the optimal level of international reserves that a small open emerging market economy should hold. The model derives a formula showing that the optimal reserve level depends on factors such as the probability and size of sudden stops in capital flows, the country's risk aversion, and the opportunity cost of holding reserves. When calibrated using data on sudden stops, the model can explain reserve levels of around 9% of GDP for plausible parameter values, similar to averages for emerging markets. However, it has difficulty explaining very high Asian reserve levels without assuming high output costs and risk aversion for sudden stops in those countries.
Application of taylor principle to lending rate pass through debate in nigeri...Alexander Decker
This document summarizes research on the pass-through of policy interest rates to retail lending rates in Nigeria. It finds that pass-through is incomplete, which contradicts the Taylor principle and implications for monetary policy effectiveness. The paper also reviews literature showing that retail rates typically do not fully adjust to changes in policy rates due to factors like bank-customer relationships and asymmetric information. An incomplete pass-through can interfere with the stabilizing role of monetary policy and alter macroeconomic stability.
Inferences from Interest Rate Behavior for Monetary Policy SignalingIOSR Journals
Weak mean reversion of interest rates towards the long term mean suggests high probability of agents in financial markets failing to interpret monetary policy signalling efficiently and financial market related interest rate unable to achieve equilibrium. Increased randomness penetrating interest rate markets is due to the weak monetary policy signalling effect which dilutes information flow from central banks’ to agents in the financial market. In such cases the effectiveness monetary policy erodes as it departs from the objectives of central banks and financial regulators
This document discusses using extreme value theory (EVT) to model policyholder behavior in extreme market conditions using variable annuity lapse data. EVT allows predicting behavior in the extremes based on nonextreme data. The paper applies EVT by fitting bivariate distributions to lapse and market indicator data above a large threshold. This provides insights into policyholder behavior in extreme markets without direct observations. The goal is a dynamic lapse formula capturing different characteristics than traditional methods.
The global economy is stabilizing after an unprecedented recession, helped by unprecedented policy support. However, the recession is not over and the recovery is expected to be sluggish. While growth is projected to be higher in 2010 than previously expected, the advanced economies are not expected to show sustained growth until the second half of 2010. Financial conditions have improved due to government intervention, but financial systems remain impaired and government support will gradually diminish.
How Did Economist Get It So Wrong Paul KrugmanPeter Ho
This document summarizes how mainstream economists failed to predict or prevent the 2008 financial crisis, despite believing they had resolved internal disputes and "solved" the problem of preventing depressions. It argues that economists mistook theoretical, mathematically elegant models of perfect markets for reality, ignoring limitations of human rationality and market imperfections that can cause crashes. It traces how mainstream economics shifted from Keynesian support for government intervention to stabilize economies to a neoclassical faith in free markets, with devastating consequences in the crisis.
1) The US recovery in the 1930s was rapid until 1937, when unemployment surged again due to a switch to contractionary fiscal and monetary policy that prolonged the Depression.
2) In 1937, fiscal stimulus from veterans bonuses and Social Security taxes disappeared, reducing the deficit by 2.5% of GDP. Additionally, the Federal Reserve doubled bank reserve requirements, unintentionally causing banks to reduce lending and precipitating recession.
3) The author argues that policymakers today must learn from 1937 and resist prematurely withdrawing stimulus until the economy reaches full employment to avoid derailing the recovery.
This document provides a summary of findings from a report by the Committee on Oversight and Government Reform regarding the potential impacts of 7 Medicaid regulations proposed by CMS. Key findings include:
1) State estimates found the regulations could reduce federal Medicaid payments to states by $49.7 billion over 5 years, more than 3 times CMS's estimate of $15 billion.
2) The regulations are likely to shift costs from the federal government to states rather than improve efficiencies.
3) The regulations could disrupt care systems for vulnerable groups and threaten the stability of safety net hospitals and clinics treating uninsured patients.
4) The regulations would impose significant administrative burdens and costs on state Medicaid programs.
5
This document summarizes the 2009 Medicare & You handbook. It provides information about Medicare coverage, costs, and options. Key points include:
- Medicare covers hospital insurance (Part A), medical insurance (Part B), Medicare Advantage plans (Part C), and prescription drug coverage (Part D).
- Coverage and costs vary depending on the plan. Part A has a deductible and Part B has a premium and deductible. Advantage plans have premiums, deductibles, and other costs.
- Individuals have choices in how they receive Medicare benefits, including Original Medicare or Medicare Advantage plans. Plans must be joined during specific enrollment periods.
- The handbook provides information to help
The document provides an overview and outlook of the global economy in the aftermath of the global financial crisis. It discusses how the crisis has led to a sharp decline in global growth, private capital flows, commodity prices, and industrial production. It also examines the policy responses of countries and risks to recovery. Key challenges going forward include strengthening confidence, coordinating policies, and mitigating the crisis's impact on low-income countries. The outlook remains uncertain with downside risks including weak medium-term growth and the potential for balance of payments crises in countries with large financing needs.
The document is a summary of the World Economic Outlook report from April 2009 published by the IMF. It discusses the state of the global economy during the financial crisis. The key points are:
1) The global economy contracted by 1.3% in 2009, the deepest post-World War II recession, with output declining in three-quarters of the global economy. Growth was projected to pick up to 1.9% in 2010 but remain sluggish.
2) Financial market stabilization was expected to take longer than previously thought, keeping financial conditions weak and reducing credit to the private sector in advanced economies in 2009-2010. Total global write-downs on assets could reach $4 trillion over two years.
This document summarizes a study that estimates a dynamic stochastic general equilibrium (DSGE) model to quantify the role of financial frictions, known as the financial accelerator mechanism, in U.S. business cycle fluctuations from 1973 to 2008. The model incorporates a high-information content credit spread index to identify the financial accelerator parameters and measure the impact of financial shocks on the real economy. Estimation results identify an operative financial accelerator, where increases in external financing costs significantly reduce investment and output. Financial disturbances accounted for significant portions of investment and output declines during economic downturns, particularly in the 1970s.
Lessons from the Great Depression for Economic Recovery in 2009Peter Ho
This document discusses lessons from the Great Depression that may help guide economic recovery efforts in 2009. It notes that while the current recession is severe, it is less severe than the Great Depression. It outlines parallels between the two events, including their origins in financial crises and asset price declines. The document discusses four key lessons from the 1930s: 1) small fiscal stimulus had limited effects so a large stimulus is needed; 2) monetary policy can help even at low rates by affecting expectations; 3) stimulus should not be withdrawn too soon; and 4) financial stability and real recovery go hand in hand. The goal is to apply these lessons to end the current recession.
The Size of the Fiscal Expansion: An Analysis for the Largest CountriesPeter Ho
The document analyzes the size of fiscal stimulus packages implemented by major countries in response to the 2008 financial crisis. It finds that the size of packages varied significantly, ranging from 4.8% of GDP for the US to 0.5% for India. This variation is explained by differences in the need for stimulus due to factors like automatic stabilizers and output gaps, as well as differences in available fiscal space constrained by public debt levels and financial sector support needs. While stimulus efforts will provide important support to growth, the outlook remains weak and downside risks remain, so some argue additional fiscal action may be needed if properly designed to not permanently increase deficits.
This document summarizes initial lessons from the financial crisis in three areas: regulation, macroeconomic policy, and the global financial system. Key failures included fragmented regulation that allowed regulatory arbitrage, a lack of coordination between macro and financial stability policies, and an inability within the global system to identify vulnerabilities. Lessons indicate regulation needs broader oversight of all systemically important financial activities, macro policies should consider financial stability risks, and greater international cooperation is required.
STOCKTAKING OF THE G-20 RESPONSES TO THE GLOBAL BANKING CRISISPeter Ho
The document provides a preliminary assessment of policy responses by G-20 countries to address the global banking crisis from September 2008 to February 2009. It finds that initial responses were reactive and aimed at containment through measures like debt guarantees and liquidity support. Key limitations identified include inadequate creditor protection if economic conditions worsen, ad hoc capital injections, and a lack of frameworks for asset management. Going forward, the document recommends a more comprehensive and coordinated international strategy across four elements: coordination of restructuring policies, cooperation on toxic asset valuation and disposal, financial institution inspections, and frameworks for public ownership of banks.
This document provides a summary of new and revised IFRS standards and interpretations that will become effective in 2009. Key changes include revisions to IAS 1 regarding financial statement presentation, IAS 27 and IFRS 3 introducing a single consolidation model, and IFRS 8 bringing segment reporting in line with US GAAP. Other standards are also amended relating to borrowing costs, business combinations, financial instruments, and share-based payments. The document outlines the implementation dates and provides high-level details of the changes required by each new or revised standard.
A Non-Random Walk Revisited: Short- and Long-Term Memory in Asset PricesPeter Ho
This paper examines the possibility of short- and long-term memory in international asset prices across 44 markets. Using random walk tests over multiple lags, the authors find mixed evidence of long memory, with some emerging markets and commodity/currency markets exhibiting long memory properties. Regression of a dummy variable indicates that markets with poorer risk-adjusted returns are more likely to reject the random walk hypothesis. Additionally, the choice of truncation lag in long memory tests is found to have little bearing on the results.
Non-Performing Loans, Prospective Bailouts, and Japan’s SlowdownPeter Ho
This document discusses Japan's prolonged economic slowdown since the early 1990s and argues that the government's delay in bailing out financial institutions burdened with non-performing loans (bad loans) played a key role. The author constructs an economic model showing how bad loans combined with delayed bailout can lead to a persistent decline in economic activity by reducing bank lending. Quantitative analysis estimates the delayed bailout may have reduced Japan's annual GDP growth by up to 0.92 percentage points, accounting for much of its slow growth.
Why the U.S. Treasury Began Auctioning Treasury Bill in 1929Peter Ho
In 1929, the U.S. Treasury introduced Treasury bills to address flaws in its financing operations from the 1920s. Specifically, Treasury debt offerings were chronically oversubscribed when sold at fixed prices, and the Treasury had to borrow in advance of its needs between its quarterly debt sales and tax payment dates. By auctioning Treasury bills regularly and on an as-needed basis, the Treasury was able to better manage its cash flows and meet its financing needs in a more flexible manner. The introduction of Treasury bills allowed the Treasury to mitigate defects in the existing system while maintaining the overall structure of its operations.
The document summarizes Martin Wolf's lecture on the failures of global finance and capital flows that have led to emerging market crises. Some key points:
1. Financial liberalization in emerging markets led to excessive risk-taking and poor regulation, fueling credit growth and asset bubbles.
2. Macroeconomic imbalances like fiscal deficits and currency pegs exacerbated risks. Currency crises then triggered financial crises as foreign debt overwhelmed many countries and companies.
3. Major crises included the Latin American debt crisis in the 1980s, the Mexican "Tequila" crisis of 1994-95, the Asian Financial crisis of 1997-98, and the Argentine crisis of 2001-02. The Asian crisis
O documento é uma entrevista com o psiquiatra Roberto Shinyashiki onde ele discute sobre heróis de verdade e a supervalorização das aparências na sociedade. Ele argumenta que falta competência ao Brasil e não autoestima, e que heróis de verdade são aqueles que trabalham para realizar seus projetos de vida em vez de impressionar os outros. Ele também critica o mundo corporativo por valorizar mais a autoestima do que a competência.
Solution Manual For Financial Accounting, 8th Canadian Edition 2024, by Libby...Donc Test
Solution Manual For Financial Accounting, 8th Canadian Edition 2024, by Libby, Hodge, Verified Chapters 1 - 13, Complete Newest Version Solution Manual For Financial Accounting, 8th Canadian Edition by Libby, Hodge, Verified Chapters 1 - 13, Complete Newest Version Solution Manual For Financial Accounting 8th Canadian Edition Pdf Chapters Download Stuvia Solution Manual For Financial Accounting 8th Canadian Edition Ebook Download Stuvia Solution Manual For Financial Accounting 8th Canadian Edition Pdf Solution Manual For Financial Accounting 8th Canadian Edition Pdf Download Stuvia Financial Accounting 8th Canadian Edition Pdf Chapters Download Stuvia Financial Accounting 8th Canadian Edition Ebook Download Stuvia Financial Accounting 8th Canadian Edition Pdf Financial Accounting 8th Canadian Edition Pdf Download Stuvia
In a tight labour market, job-seekers gain bargaining power and leverage it into greater job quality—at least, that’s the conventional wisdom.
Michael, LMIC Economist, presented findings that reveal a weakened relationship between labour market tightness and job quality indicators following the pandemic. Labour market tightness coincided with growth in real wages for only a portion of workers: those in low-wage jobs requiring little education. Several factors—including labour market composition, worker and employer behaviour, and labour market practices—have contributed to the absence of worker benefits. These will be investigated further in future work.
2. Elemental Economics - Mineral demand.pdfNeal Brewster
After this second you should be able to: Explain the main determinants of demand for any mineral product, and their relative importance; recognise and explain how demand for any product is likely to change with economic activity; recognise and explain the roles of technology and relative prices in influencing demand; be able to explain the differences between the rates of growth of demand for different products.
Understanding how timely GST payments influence a lender's decision to approve loans, this topic explores the correlation between GST compliance and creditworthiness. It highlights how consistent GST payments can enhance a business's financial credibility, potentially leading to higher chances of loan approval.
How Does CRISIL Evaluate Lenders in India for Credit RatingsShaheen Kumar
CRISIL evaluates lenders in India by analyzing financial performance, loan portfolio quality, risk management practices, capital adequacy, market position, and adherence to regulatory requirements. This comprehensive assessment ensures a thorough evaluation of creditworthiness and financial strength. Each criterion is meticulously examined to provide credible and reliable ratings.
[4:55 p.m.] Bryan Oates
OJPs are becoming a critical resource for policy-makers and researchers who study the labour market. LMIC continues to work with Vicinity Jobs’ data on OJPs, which can be explored in our Canadian Job Trends Dashboard. Valuable insights have been gained through our analysis of OJP data, including LMIC research lead
Suzanne Spiteri’s recent report on improving the quality and accessibility of job postings to reduce employment barriers for neurodivergent people.
Decoding job postings: Improving accessibility for neurodivergent job seekers
Improving the quality and accessibility of job postings is one way to reduce employment barriers for neurodivergent people.
Falcon stands out as a top-tier P2P Invoice Discounting platform in India, bridging esteemed blue-chip companies and eager investors. Our goal is to transform the investment landscape in India by establishing a comprehensive destination for borrowers and investors with diverse profiles and needs, all while minimizing risk. What sets Falcon apart is the elimination of intermediaries such as commercial banks and depository institutions, allowing investors to enjoy higher yields.
Economic Risk Factor Update: June 2024 [SlideShare]Commonwealth
May’s reports showed signs of continued economic growth, said Sam Millette, director, fixed income, in his latest Economic Risk Factor Update.
For more market updates, subscribe to The Independent Market Observer at https://blog.commonwealth.com/independent-market-observer.
"Does Foreign Direct Investment Negatively Affect Preservation of Culture in the Global South? Case Studies in Thailand and Cambodia."
Do elements of globalization, such as Foreign Direct Investment (FDI), negatively affect the ability of countries in the Global South to preserve their culture? This research aims to answer this question by employing a cross-sectional comparative case study analysis utilizing methods of difference. Thailand and Cambodia are compared as they are in the same region and have a similar culture. The metric of difference between Thailand and Cambodia is their ability to preserve their culture. This ability is operationalized by their respective attitudes towards FDI; Thailand imposes stringent regulations and limitations on FDI while Cambodia does not hesitate to accept most FDI and imposes fewer limitations. The evidence from this study suggests that FDI from globally influential countries with high gross domestic products (GDPs) (e.g. China, U.S.) challenges the ability of countries with lower GDPs (e.g. Cambodia) to protect their culture. Furthermore, the ability, or lack thereof, of the receiving countries to protect their culture is amplified by the existence and implementation of restrictive FDI policies imposed by their governments.
My study abroad in Bali, Indonesia, inspired this research topic as I noticed how globalization is changing the culture of its people. I learned their language and way of life which helped me understand the beauty and importance of cultural preservation. I believe we could all benefit from learning new perspectives as they could help us ideate solutions to contemporary issues and empathize with others.
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Gust Lopez Salido
1. Monetary Policy and the Equity Premium∗
Christopher Gust and David L´pez-Salido†
o
Federal Reserve Board
December 2008
Abstract
Recent research has emphasized that risk premia are important for understanding
the monetary transmission mechanism. An important result in this literature is that
unanticipated changes in monetary policy affect equity prices primarily through changes
in risk rather than through changes in real interest rates. To account for this finding,
we develop a DSGE model in which monetary policy generates endogenous movements in
risk. The key feature of our model is that asset and goods markets are segmented, because
it is costly for households to transfer funds between these markets, and they may only
infrequently update their desired allocation of cash across these two markets. Our model
can account for the mean returns on equity and the risk-free rate, and generates variations
in the equity premium that help explain the response of stock prices to monetary shocks.
∗
We thank Orazio Attanasio, John Driscoll, Andy Levin, Harald Uhlig, and Annette Vissing-Jørgensen and
seminar participants at Georgetown University, International Monetary Fund, European Central Bank, and the
Federal Reserve Bank of San Francisco for useful comments. The views expressed in this paper are solely the
responsibility of the authors and should not be interpreted as reflecting the views of the Board of Governors of
the Federal Reserve System or of any other person associated with the Federal Reserve System.
†
Corresponding Author: David L´pez-Salido. Email addresses: david.lopez-salido@frb.gov, christo-
o
pher.gust@frb.gov.
2. 1 Introduction
Monetary policy primarily affects the macroeconomy through its effect on financial markets. In
standard monetary models, this interaction between the financial and real sides of the economy
occurs through short-term interest rates, as changes in monetary policy affect the conditional
mean of the short-term interest rate which in turn macroeconomic variables such as output,
employment, and inflation. These models, however, abstract from another channel through
which monetary policy affects financial markets and the macroeconomy. In these models, there
is little or no role for monetary policy to influence the conditional variances of variables or the
perceived riskiness of the economy.1 In contrast, Bernanke and Kuttner (2005) provide evidence
that monetary policy does affect risk, suggesting that standard monetary models are potentially
missing an important channel through which monetary shocks propagate from the financial to
the real economy. Using high-frequency data, they show that, while an unanticipated easing of
monetary policy lowers real short-term interest rates, it also has a large quantitative effect on
equity returns occurring through a reduction in the equity premium.
In this paper, we develop a DSGE model in which monetary policy affects the economy
through the standard interest rate channel and through its effect on economic risk. The key
feature of our model is that asset and goods markets are segmented, because it is costly for
households to transfer funds between these markets. Accordingly, they may only infrequently
update their desired allocation of cash between an account devoted to purchasing goods and
a brokerage account used for financial transactions. The optimal decision by an individual
household to rebalance their cash holdings is a state-dependent one, reflecting that doing so
involves paying a fixed cost in the presence of uncertainty. Households are heterogenous in this
fixed cost, and only those households that rebalance their portfolios during the current period
matter for determining asset prices. Because the fraction of these household changes over time
1
See Alvarez, Atkeson, and Kehoe (2007a) for an extended discussion of this point. In a companion paper,
Alvarez, Atkeson, and Kehoe (2007b) argue that the evidence on the relationship between interest rates and
exchange rates is consistent with movements in these variables that are driven mainly by changes in conditional
variances.
1
3. in response to both real and monetary shocks, risk in the economy is both time-varying and
endogenous.
We show that our model, unlike standard monetary models, is able to account for the
Bernanke and Kuttner (2005) evidence. In particular, a monetary easing in our model leads to
a fall in real interest rates and a reduction in the equity premium. Furthermore, for reasonable
calibrations of the model, the reduction in the equity premium is an important reason why
stock prices rise in response to a monetary easing.
In addition to comparing our model to the evidence of Bernanke and Kuttner (2005), we also
examine the model’s ability to account for the mean returns on equity and the risk-free rate.
As shown by Mehra and Prescott (1985), standard representative agent models with power
utility have difficulty quantitatively accounting for these moments. For reasonable calibrations
of monetary and technology shocks, our model is able to match the observed means on equity
and risk-free rates with a power utility function that implies constant relative risk aversion
equal to two. We show that to match these moments, the average fraction of households that
reallocates funds across markets can not be too large. For our benchmark calibration, about
15 percent of households, on average, rebalance their portfolios in a quarter. Underlying this
average fraction of rebalancing, there is a considerable degree of heterogeneity across households
in our model, with some rebalancing every period and another fraction never rebalancing away
from their initial allocation.
Recent microdata on household finance provides strong support for infrequent portfolio
rebalancing. For instance, Calvet, Campbell, and Sodini (2008) document that, while there is
little rebalancing of the financial portfolios of stockholders by the average household, there is a
great deal of heterogeneity at the micro level with some households rebalancing these portfolios
very frequently. Brunnermeier and Nagel (2008) provide evidence that household portfolio
allocation is inertial. Surveys conducted by the Investment Company Institute (ICI) and the
Securities Industry Association (SIA) also suggest that households rebalance their portfolios
infrequently. For instance, in 2004, the median number of total equity transactions for an
individual was four. In addition, sixty percent of equity investors did not conduct any equity
2
4. transactions during 2004.
Our model is most closely related to and builds on the analysis of Alvarez, Atkeson, and
Kehoe (2007b). They introduce endogenously segmented markets into an otherwise standard
cash-in-advance economy and show how changes in monetary policy can induce fluctuations in
risk. However, our model differs from theirs in two important respects. First, we incorporate
production and equity returns. Second and more importantly, in their model, risk is endogenous,
because the fraction of households that participates in financial markets is state-dependent.
In our model, all households participate in financial markets, but it is costly to reallocate
cash between the asset and goods markets from a household’s initial allocation. In other
words, endogenous asset segmentation occurs along an intensive margin in our model rather
than an extensive margin. This distinction is important, because we show that for reasonable
calibrations we can not account for the Bernanke and Kuttner (2005) evidence or match the
average equity premium in their framework.2
Our paper is also related to portfolio choice models that emphasize infrequent adjustment.
In this literature, the paper most closely related to ours is Abel, Eberly, and Panageas (2007).3
They also model infrequent adjustment of cash between a transaction account used to purchase
goods and another account used to purchase financial assets. Their framework differs from ours,
since they do not consider the role of monetary policy and use a partial equilibrium framework
in which returns are exogenous. However, they show that infrequent portfolio adjustment can
arise due to rational inattention on the part of households.
The rest of this paper proceeds as follows. The next section describes the model and its cali-
bration. Section 3 presents the results, emphasizing the model’s ability to match unconditional
moments such as the mean returns on equity and a risk-free asset as well as the conditional
responses of these variables to a monetary policy shock. Section 4 concludes and discusses
2
Polkovnichenko (2004), Vissing-Jorgensen (2003), and Gomes and Michaelides (2006) also show that it
is difficult to match the equity premium in a model with endogenous stock market participation. Guvenen
(2005) considers a model in which stock market participation is fixed exogenously and shows that this feature
in addition to heterogeneity in preferences can help account for the average equity premium.
3
Also, see Lynch (1996), Marshall and Parekh (1999), and Gabaix and Laibson (2001).
3
5. directions for future research.
2 The Model
Our model builds on the cash-in-advance economy of Alvarez, Atkeson, and Kehoe (2007b),
which we extend to incorporate equity prices. Our model differs from theirs, since we emphasize
that time-varying risk is driven by costly portfolio rebalancing of financial accounts rather than
limited participation in financial markets.
Our economy is populated by a large number of households, firms, and a government sector.
There are infinite number of periods, and in periods t ≥ 1 trade occurs in financial and goods
markets. In period t = 0 there is an initial round of trade in bonds in the asset market with
no trade in goods markets. In the asset market, households trade a complete set of state-
contingent claims, and in the goods market, households use money to buy goods subject to a
cash-in-advance constraint.
We assume that trade in these two markets takes place in separate locations so that they
are segmented from each other. A household can pay a fixed cost to transfer funds between the
asset and goods markets. This fixed cost is constant over time but varies across households.
We refer to a household that pays this fixed cost as actively rebalancing cash allocated for
consumption and asset markets, and those that do not as inactive.
There are two sources of uncertainty in our economy — aggregate shocks to technology,
Zt , and money growth, µt . We let st = (zt , µt ) index the aggregate event in period t, and
st = (s1 , ..., st ) denote the state, which consists of the aggregate shocks that have occurred
through period t.
2.1 Firms
There is large number of perfectly competitive firms, which each have access to the following
technology for converting capital, K(st−1 ), and labor, L(st ), into output, Y (st ) at dates t ≥ 1:
1−α
Y (st ) = K(st−1 )α exp(zt )L(st ) . (1)
4
6. We assume that the technology shock follows a first-order autoregressive process:
zt = ρz zt−1 + zt , (2)
2
where zt ∼ N (0, σz ) for all t ≥ 1. Capital does not depreciate, and there exists no technology
for increasing or decreasing its magnitude. We adopt the normalization that the aggregate
stock of capital is equal to one. Labor is supplied inelastically by households, its supply is also
normalized to one.
Following Boldrin, Christiano, and Fisher (1997), we assume that firms have a one-period
planning horizon. To operate capital in period t + 1, a firm must purchase it at the end of
period t from those firms operating during period t. To do so, a firm issues equity S(st ) and
purchases capital subject to its financing constraint,
Pk (st )K(st ) ≤ S(st ), (3)
where Pk (st ) denotes the price of capital in state, st .
A firm derives revenue from its sale of output, P (st+1 )Y (st+1 ), and the sale of its capital
stock, Pk (st+1 )K(st ), at the end of period t + 1. A firm’s expenses include its obligations on
equity, (1 + Re (st+1 ))S(st ), and payments to to labor, W (st+1 )L(st+1 ). A firm’s net revenues,
V (st+1 ), including its expenses, must be greater than zero in each state so that:
V (st+1 ) = P (st+1 )Y (st+1 ) + Pk (st+1 )K(st ) − (1 + Re (st+1 ))S(st ) − W (st+1 )L(st+1 ) ≥ 0. (4)
The firm’s problem at date t + 1 is to maximize V (st+1 ) across states of nature by choice of
K(st ) and L(st+1 ) subject to (1) and (3). This problem implies that the financing constraint
(3) is satisfied as a strict equality in equilibrium. The equilibrium real wage, w(st+1 ) is given
by:
W (st+1 ) Y (st+1 )
w(st+1 ) = = (1 − α) , (5)
P (st+1 ) L(st+1 )
Linear homogeneity of the firm’s objective, together with the weak inequality in equation (4)
imply that V (st+1 ) = 0 for all st+1 so that:
t+1
1 + Re (st+1 ) α YK(st ) ) + pk (st+1 )
(s
e t+1
1 + r (s ) = = . (6)
π(st+1 ) pk (st )
5
7. Pk (st ) P (st+1 )
In the above, pk (st ) = P (st )
denotes the real price of capital and π(st+1 ) = P (st )
is the
economy’s inflation rate.
2.2 The Government
The government issues one-period state-contingent bonds and controls the economy’s money
stock, Mt . At date 0, the government also issues an annuity at price, PA , which has a constant
payoff A0 in units of consumption. Its budget constraints at date 0 is given by:
¯
B= q(s1 )B(s1 )ds1 + PA A0 , (7)
s1
¯
where B is given and q(s1 ) denotes the price of the state-contingent bond, B(s1 ). At dates
t ≥ 1, the government’s budget constraint is given by:
B(st ) + Mt−1 + P (st )A0 = Mt + q(st , st+1 )B(st , st+1 )dst+1 , (8)
st+1
with M0 > 0 given. Finally, the government injects cash into the economy via a first-order
Mt
autoregressive process for money growth, µt = Mt−1
:
µt = (1 − ρµ )¯ + ρµ µt−1 +
µ µt , (9)
2
where µ > 0, and
¯ µt ∼ N (0, σµ ) for all t ≥ 1.
2.3 Households
Households inelastically supply their labor to firms and purchase the output of the firms. A
household can also purchase and sell bonds and stocks in asset markets. However, we assume
that the asset and goods markets are segmented so that a household must pay a real fixed
cost, γ, to transfer cash between them. This cost is constant for a household but differs across
households according to the distribution F (γ) with density f (γ). Specifically, we assume some
positive mass has a zero fixed cost so that F (0) > 0, while the distribution for the remaining
households is given by γ ∼ N (˜m , σγ ), where γ = log(γ).
˜ γ ˜
6
8. At the beginning of period t, a household of type γ starts the period with money balances,
M (st−1 , γ), in the goods market. They can then decide whether to transfer additional funds,
P (st )x(st , γ), between the goods and asset markets. We define the indicator variable z(st , γ)
to equal zero if these transfers are zero and one if a household makes a transfer. We also allow
the stream of income from an annuity purchased by the household at date 0 to be available for
consumption at dates t ≥ 1. Unlike the fixed cost of transferring x(st , γ) across markets, we
assume that there are no fixed costs associated with the annuity, so that a household’s initial
allocation of cash across markets is a relatively costless one.
With these sources of cash available for consumption, a household faces the cash-in-advance
constraint:
P (st )c(st , γ) = M (st−1 , γ) + P (st )x(st , γ)z(st , γ) + P (st )A(γ), (10)
where A(γ) is the constant stream of income in units of consumption derived from the annuity
purchased by household γ at date 0. Equation (10) holds as a strict equality, implying that a
household can not store cash in the goods market from one period to the next.4 This assumption
greatly simplifies our analysis, and in the appendix, we provide sufficient conditions for this
constraint to hold strictly as an equality. In the asset market, a household of type γ begins the
period with holdings of bonds, B(st , γ), and receives a return on any equity purchased in the
previous period. Both of these sources of funds are available as cash in the asset market and
can either be reinvested, or if the household pays its fixed cost, the funds can be transferred
to the goods market. Accordingly, the household’s cash constraint in the asset market at dates
t ≥ 1 is given by:
B(st , γ) + (1 + Re (st ))S(st−1 , γ) = q(st , st+1 )B(st , st+1 , γ)dst+1 + (11)
st+1
S(st , γ) + P (st )[x(s , γ) + γ]z(st , γ).
t
As shown in the appendix, this constraint is satsified as a strict equality as long as nominal
interest rates are positive. In period 0, a household’s cash constraint in the asset market reflects
4
For models in which households choose to store cash in the goods market, see Abel, Eberly, and Panageas
(2007), Khan and Thomas (2007), and Alvarez, Atkeson, and Edmond (2003).
7
9. its purchases of the annuity and its initial level of assets, B(γ):
B(γ) = q(s1 )B(s1 )ds1 + PA A(γ). (12)
s1
The constant payment stream A(γ) is independent of the state of nature but does depend
on a household’s type. A household with a relatively high γ will in general demand a different
quantity of the annuity than a low cost household. In addition, a household that purchases
a positive amount of the annuity, may still choose to pay its fixed cost γ, and make a state-
dependent transfer, x(st , γ), in periods in which a large enough shock occurs. Since doing
so essentially involves reallocating cash in the two markets away from a household’s initial
allocation, A(γ), we call this version of the model, the “endogenous rebalancing model”.
Given that both the cash-in-advance constraint, equation (10), and asset market constraint,
equation (11), hold with strict equality, we can write a household’s budget constraint for t ≥ 1
simply as:
M (st , γ) = P (st )w(st ). (13)
This condition greatly simplifies our analysis, because it implies that at the beginning of each
period, all households regardless of type hold the same amount of cash. Consequently, we do
not need to keep track of each households’ money holdings over time. It is also convenient to
substitute this expression for M (st , γ) into the cash-in-advance constraint, and rewrite it as:
w(st−1 )
c(st , γ) = + x(st , γ)z(st , γ) + A(γ). (14)
π(st )
When A(γ) = 0 for all γ, then our model is similar to the one studied by Alvarez, Atkeson,
and Kehoe (2007b). In this case, asset markets are completely segmented from goods markets
for agents who do not transfer x(st , γ) between them. As a result, consumption of these inactive
households is simply based on their previous period’s wage income, as their consumption is
completely isolated from either stock or bond returns. We call this version of our model, the
“endogenous participation model”, because the decision to transfer funds from asset to the
goods market determines whether a household participates in financial markets. In contrast, in
the “endogenous rebalancing” model, all households participate in financial markets. Instead,
8
10. their decision to transfer funds x(st , γ) at date t amounts to a rebalancing of cash from their
initial allocation determined at date 0.
In the endogenous rebalancing model, a household’s problem is to choose A(γ) and
∞
{c(st , γ), x(st , γ), z(st , γ), M (st , γ), B(st , γ), S(st , γ)}t=1 to maximize:
∞
βt U (c(st , γ))g(st )dst (15)
t=1 st
subject to equations (10)-(13), taking prices and initial holdings of money, bonds, and stocks
as given. In equation (15), the function g(st ) denotes the probability distribution over history
st . We also assume that preferences are given by:
c1−σ
U (c) = , (16)
1−σ
where σ is the coefficient of constant relative risk aversion.
2.4 Market Clearing
The resource constraint in our economy is given by:
∞
Y (st ) = c(st , γ) + γz(st , γ) f (γ)dγ, (17)
0
while market clearing in factor markets requires K(st ) = 1 and L(st ) = 1. In asset markets, for
stock and bond markets to clear at dates t ≥ 0 we have:
∞ ∞
S(st ) = S(st , γ)f (γ)dγ B(st+1 ) = B(st+1 , γ)dγ.
0 0
¯ ∞ ¯ ∞
At date 0, we also have B = 0
B(γ)f (γ)dγ and A0 = 0
A(γ)f (γ)dγ. Market clearing in the
money market for t ≥ 1 is given by:
∞
M (st−1 , γ) + P (st )[x(st , γ) + γ]z(st , γ) + P (st )A(γ) f (γ)dγ = Mt , (18)
0
where the presence of the fixed cost reflects it is paid using cash from the asset market.
An equilibrium is a collection of asset prices, {PA , q(st ), Re (st )}, wages, and goods prices
{Pk (st ), P (st )} which together with money, asset holdings, and allocations, {c(st , γ), x(st , γ),
9
11. z(st , γ))}, for households that for each transfer cost γ, the asset holdings and allocations
solve the the households’ optimization problem. These prices together with the allocations
{S(st ), K(st ), Y (st+1 ), L(st+1 )} satisfies the firms’ optimization problems. Finally, the gov-
ernment budget constraint holds and the resource constraint along with the market clearing
conditions for capital, labor, bonds, stocks, and money are all satisfied.
2.5 Equilibrium Characterization
We now solve for the equilibrium consumption and transfers of households in the endogenous
rebalancing model. We show that there will be a variable fraction of active households that
choose to make the state-dependent transfer and a remaining fraction that does not. We then
characterized the link between the consumption of active households and equity returns.
2.5.1 Consumption and Transfers
We begin by characterizing a household’s consumption conditional on their choice of paying the
fixed cost of making a state dependent transfer (i.e., their choice of z(st , γ). To do so, we use
the fact that market clearing of factor markets implies that Y (st ) = exp((1 − α)zt ). In addition,
we can determine the economy’s price level and inflation rate by substituting equations (10)
and (17) into the money market clearing condition to write:
Mt µt
P (st ) = , π(st ) = . (19)
exp[(1 − α)zt ] exp[(1 − α)(zt − zt−1 )]
With these expressions, we can show that the consumption of an inactive household (i.e., one
that sets z(st , γ) = 0) is given by:
w(st ) (1 − α)exp[(1 − α)zt ]
cI (st , γ) = + A(γ) = + A(γ). (20)
µt µt
From this expression, we can see that inflation is distortionary, since it reduces the consumption
of inactive households. This effect induces some households to pay the fixed cost and become
active. An increase in technology will also induce households to become active. While the
consumption of inactive households rises due to an increase in wages following a technology
10
12. shock, the benefits of being active are even greater, reflecting that active consumption is also
boosted by higher capital income.
There is perfect risk-sharing amongst active households, and these agents have identical
consumption for aggregate state st :
cA (st , γ) = cA (st ). (21)
Thus, the consumption of active households is independent of γ. To further characterize, the
consumption of active and inactive households, we need to determine A(γ), the initial allocation
of cash from the asset market that is devoted to consumption. In the appendix, we show that
the price of the annuity is given by
∞
PA = Q(st )P (st )dst , (22)
t=1 st
where Q(st ) = Πt q(sj ) and a household’s choice of A(γ) must satisfy:
j=1
∞
βt U (cA (st )) − U (cI (st , γ)) (1 − z(st , γ))g(st )dst = 0. (23)
t=1 st
This latter condition states that in the states of the world in which a household is inactive
(i.e., z(st , γ) = 0), the household chooses A(γ) to equate the expected discounted value of
marginal utility of its consumption to the expected discounted value of the marginal utility
of the consumption of the active households in those states of the world. Thus, the annuity
provides a minimal level of consumption insurance to a household whose fixed cost γ is so large
that they would never actively rebalance their cash holdings away from A(γ). Moreover, an
agent who never actively rebalances their cash accounts will choose A(γ) > 0. This reflects
that consumption of the active households reflects capital income from equity markets, and the
consumption of a household that was always inactive and did not purchase the annuity would
not. Accordingly, the only way for a completely inactive household to satisfy equation (23) is
to purchase the annuity at date 0 (i.e., set A(γ) > 0) and in this way get some of the proceeds
from capital income.
While equation (23) places restrictions on the choice of A(γ) for agents that are inactive in
at least one state of the world, this condition is irrelevant for agents that actively rebalance their
11
13. portfolios in each state of the world. In this case, a household’s choice of A(γ) is redundant,
since they can use x(st , γ) to achieve their desired level of consumption. Consequently, it is
convenient to define the function A(γ) only for γ such that γ > γM in ≥ 0, where γM in is defined
as the household which is active in every state of the world.
With the A(γ) defined only for γ > γM in ≥ 0, we now turn to characterizing a household’s
decision to actively rebalance or not. In the appendix, we provide sufficient conditions for the
existence of an equilibrium. In addition, we show that the optimal choice of z(st , γ) has a cutoff
rule in which households with γ ≤ γ (st ) pay the fixed cost and consume cA (st ). In addition,
¯
the equilibrium values of the fixed cost of the marginal household, γ (st ), and cA (st ) satisfy:
¯
∞ γ (st )
¯
t t w(st )
F (¯ (s ))cA (s ) +
γ [ + A(γ)]f (γ)dγ = exp[(1 − α)zt ] − γf (γ)dγ, (24)
γ (st )
¯ µt 0
w(st ) w(st )
U [cA (st )] − U [ + A(¯ (st )] = U [cA (st )] cA (st ) −
γ − A(¯ (st )) + γ (st ) .
γ ¯ (25)
µt µt
Equation (24) is the resource constraint expressed using the equilibrium consumptions of in-
active and active types as well as γ (st ).
¯ Equation (25) states that the net gain for the
marginal household of actively rebalancing is equal to the cost of transferring funds across
t
the two markets. The net gain, U (cA (st )) − U ( w(s ) + A(¯ (st )), is simply the difference
µt
γ
in the level of utility from being active as opposed to inactive, while the cost reflects the
fixed cost of transferring funds plus the amount transferred by the marginal household (i.e.,
w(st )
x(st , γ (st )) = cA (st ) −
¯ µt
− A(¯ (st )).
γ
According to equations (24) and (25), the fixed cost of the marginal investor as well as
the consumption of active rebalancers depend on the current levels of technology and money
growth and not future or past values of the shocks. These variables also depend on the initial
allocation of funds devoted to the goods market, A(γ). More generally, equations (23)-(25)
jointly determine cA (st ), γ (st )), and the function A(γ) for γ > γM in .
¯
To solve for these variables, we need to approximate the function A(γ) for γ > γM in .
Given A(γ), we can then use equations equations (24) and (25) to determine cA (st ) and γ (st )
¯
exactly. To approximate A(γ), we re-express equation (23) as a stochastic difference equation
and following Judd (1999) use the linear Fredholm integral equations and quadrature to solve
12
14. A(γ) at a finite number of points. We then determine A(γ) using piecewise linear interpolation.
For details regarding this solution procedure, see the appendix.
2.5.2 Consumption of Rebalancers and the Equity Premium
In our economy, the asset pricing kernel depends on the consumption of the rebalancers and is
given by:
U [cA (st+1 )]
m(st , st+1 ) = β . (26)
U [cA (st )]
This pricing kernel is the state-contingent price of a security expressed in consumption units
and normalized by the probabilities of the state. This pricing kernel can be used to determine
the real risk-free rate (rf ) as well as the real return on equity (re ). These returns are given by:
[1 + rf (st )]−1 = m(st , st+1 )g(st+1 |st )dst+1 , (27)
st+1
1= m(st , st+1 )[1 + re (st , st+1 )]g(st+1 |st )dst+1 , (28)
st+1
g(st+1 )
where g(st+1 |st ) = g(st )
denotes the probability of state st+1 conditional on state st . From
equation (29) in the firm’s problem, the equilibrium real return on equity is given by:
[α exp[(1 − α)zt+1 ] + pk (st+1 )]
1 + re (st+1 ) = . (29)
pk (st )
Using these two equations, we can then define the equity premium in our economy as:
e
Et [1 + rt+1 ] e
f
= 1 − covt mt+1 , 1 + rt+1 , (30)
1+ rt
where for convenience we have switched notation to express both the expected return on eq-
uity and the covariance between the pricing kernel and the return on equity, which are both
conditional on the state of the world at date t.
To solve for asset prices in our economy, we need to determine the price of capital, which is
equivalent to stock prices in our economy. To do so, we use equations (28) and (29) to express
the price of capital as a stochastic difference equation. As discussed in the appendix, we then
use the linear Fredholm integral equations and the Nystrom extension to determine the decision
rule for the price of capital.
13
15. 2.6 Parameter Values
For our benchmark calibration, we set the discount factor, β = 0.99, to be consistent with a
quarterly model. The economy’s capital share, α, is equal to 0.36. For the coefficient of relative
risk aversion, we used a range of values between 2 and 4, broadly consistent with the survey
of the literature in Hall (2008). For the distribution over the fixed cost, we choose benchmark
values of γm = exp(˜m ) = 0.02, σγ = 0.35, and F (0) = 0. Since this distribution is crucial
γ
to our analysis, we also consider a range of values for γm . In our model, absent the small
average transaction cost, the aggregate consumption process corresponds to the technology
shock. Therefore, we calibrated the parameters governing the process for technology based on
the time series properties of aggregate consumption. We set ρz = 0.97 and based on annual
consumption data from 1889-2004, we set σz = 0.013. These values imply that the annualized
standard deviation for consumption growth in our model is slightly higher than 3 percent. For
the money growth process, we used quarterly data on M2 over the sample period 1959:Q1-
2007:Q4 and estimated ρµ = 0.68 and σµ = 0.007. We set µ to be consistent with an average,
¯
annualized money growth rate of 4%.
3 Results
Before discussing the model’s implications for monetary policy and the equity premium, it is
helpful to characterize the non-stochastic steady state of our model.
3.1 Deterministic Steady State
In a deterministic environment, the endogenous rebalancing model reduces to a representative
agent economy. This model only becomes interesting in the presence of uncertainty; neverthe-
less, it is useful to compare its deterministic steady state with the version of the model with
endogenous participation.
In the non-stochastic steady state of the endogenous rebalancing model, all households will
have the same level of consumption. According to equation (23), a household that chooses to
14
16. be inactive obtains the same level of consumption as an active household. An inactive can
1−α
obtain such a level of consumption by choosing their annuity such that cA = cI = µ
+ A,
where A is the constant value of the annuity for all inactive households. With consumption the
same across households, all households with γ > 0 will never rebalance their portfolios, and the
households with γ = 0 will be indifferent between rebalancing or using the non-state contingent
transfer, A.
In the non-stochastic steady state of the endogenous participation model (i.e., A(γ) = 0 for
all γ), the consumption of active households exceeds the consumption of inactive households,
1−α
who only receive cI = µ
. By choosing to be inactive, these agents do not receive the capital
income associated with participating in the stock market. Given this difference in consumption
levels, all households will participate in financial markets for our benchmark value of γm and σγ .
Later, we consider alternative calibrations in which the participation rate in financial markets
is less than one.
3.2 Endogenous Rebalancing and the Equity Premium
Figure 1 shows the sample averages for the risk-free rate and the equity premium (see the red
dot labeled “U.S. Data”) taken from Cecchetti, Lam, and Mark (1993). We also report 5%
confidence ellipse, based on their estimates. The figure also shows the average equity premium
and risk-free rate in the endogenous rebalancing model using our benchmark calibration with
σ = 3.5 This calibration leads to an average equity premium of 6.6% and a risk-free rate of
1.5%.
Moving from southeast to northwest along the blue line with circles, each point reports the
equity premium and risk-free rate for different values of γm , which leads to a different average
fraction of rebalancers. There are two basic results that can be evinced from this line. First,
decreasing the average fraction of rebalancers (by increasing γm ) produces a rise in the equity
premium and fall in the risk-free rate. Second, if the fraction of household rebalancers lies
between 10% and 20%, then our model lies within the 95% confidence region.
5
These results are based on simulating the model economy 500 times using a sample size of 200 observations.
15
17. The green line with squares in Figure 1 shows the results if we vary σ in the endogenous
rebalancing model. Raising the coefficient of relative risk aversion has a similar effect on the
equity premium and risk-free rate as lowering the average fraction of rebalancers via γm . As the
coefficient of relative risk aversion increases, the mean equity premium rises and the risk-free
rate falls. For values of σ between 2 and 4, the combination of mean returns on equity and the
risk-free asset lies within the 95% confidence region. For comparison purposes, the magenta line
with triangles in the southeast corner of the figure shows the results for the standard cash-in-
advance economy with a representative agent. In this model, as in Mehra and Prescott (1985),
the only way to match the observed equity premium is to increase the coefficient of relative risk
aversion to an implausibly high level.
Figure 2 shows the mean of the equity premium and risk-free rate for the endogenous
participation model of Alvarez, Atkeson, and Kehoe (2007b) with σ = 3. The square along
the green line in southeast corner of the figure shows the results for our calibration of this
model for different values of the capital share, α. For α = 0.36, the model fails to match the
observed value of the equity premium, as the average participation rate is 1. Moving towards
the northwest along the squared-green line, the value of α is lowered so that the capital income
share becomes smaller. Only when the income obtained from equity is implausibly small can
the limited participation model account for the observed equity premium.6
3.3 Understanding the Mechanism
Figure 2 demonstrates the critical role that the annuity plays in our analysis in accounting
for the equity premium puzzle. When A(γ) = 0 for all γ, as in the endogenous participation
model, a fraction of agents are excluded from financial markets. Given a reasonable capital
share, there is a large incentive to participate in equity markets and receive a share of the
capital income. This incentive makes it difficult for this model to match the average equity
6
We also raised the value of γm , which has the effect of lowering the average participation rate in financial
markets. Values of γm that imply participation rates as low as 10% are still outside the 95% confidence region
for the mean risk-free rate and equity premium.
16
18. premium. In contrast, in the endogenous rebalancing model, through their choice of A(γ) at
date 0, all households participate in financial markets. However, some households, because of
their fixed cost, rely entirely on a non-state contingent plan for transferring funds between asset
and goods markets.
The top panel of Figure 3 shows the demand schedule for the annuity for households with
a fixed cost greater than zero (i.e., households that rebalance at least once in their lifetime).
Demand for the annuity is increasing in a household’s fixed cost up to a threshold value of
γ. This function is increasing, because a household with a higher fixed cost anticipates that
they will be rebalance their portfolio less frequently and demands a larger value of the annuity
to help insure against consumption losses. Households at or beyond the threshold value of γ
never actively use state-contingent transfers between asset and goods markets. Accordingly,
these households all choose the same level of the annuity. Figure 3 also makes clear that
in equilibrium, the demand for the annuity is relatively constant across households, varying
between 0.361 and 0.364, or a level slightly higher than the economy’s capital share.
To understand the role of A(γ) in helping the endogenous rebalance model account for the
data, we begin by noting that the equilibrium in our model can be described by equations
(24) and (25) for a given A(γ). These two equations determine the combination of equilibrium
values of the consumption of rebalancers and the fixed cost of the marginal rebalancer. Given
that A(γ) is nearly constant, it is helpful for illustrative purposes to assume momentarily that
A(γ) is constant for all inactive households. Furthermore, To get closed form solution for these
equations and without loss of generality, we also assume that σ = 2 and F (γ) is uniformly
distributed between [0, γu ]. Under these assumptions, it is convenient to rewrite these two
equation as follows:7
γ
¯ γ
¯ γ2
¯
cA + (1 − )cI = exp[(1 − α)z] − , (31)
γu γu 2γu
(cA − cI )2 = cI γ .
¯ (32)
The first equation represents the combination of values of γ and cA that satisfy goods market
¯
γ
¯
clearing, and can be used to express the fraction of rebalancers (i.e., γu
) as a function of their
7
Given that these equations are static, we simplify our notation, ignoring that these variables depend on st .
17
19. consumption. We call this schedule the GM curve for goods market clearing. For cA > cI
1−α
where cI = µ
+ A, the middle panel of Figure 3 shows that this curve is downward sloping.
This reflects that an increase in γ raises the average level of transaction costs in the economy,
reducing real resources, and lowering the consumption of rebalancers.
The second equation is defined over the same variables and characterizes the marginal
household’s decision to rebalance its portfolio (i.e., the type γ household). We call this schedule
¯
the MR curve in reference to this marginal rebalancer. For σ = 2, the middle panel of Figure
3 shows that this curve is a parabola with a minimum occurring at cI . For cA > cI , the
state-contingent transfer of an active household (i.e. x = cA − cI ) is positive, as is the cost
of transferring funds. However, a rise in the consumption of active households, all else equal,
makes it more attractive to make the state contingent transfer, and thus for cA > cI , the MR
schedule is increasing.
Figure 3 displays the equilibrium in the endogenous rebalancing model as the intersection
of these two curves. In the endogenous rebalancing model, this intersection occurs at a point in
which cA > cI , though consumption of a rebalancer is not much higher than the consumption
of a non-rebalancer, reflecting their purchase of the annuity. In contrast, the bottom panel of
Figure 3 shows that the equilibrium in the endogenous participation model occurs at a point in
which active consumption is much higher than inactive consumption (given by the minimum of
the parabola). The equilibrium financial market participation rate shown in the bottom panel
is also much higher than the the rate of rebalancing that occurs in equilibrium in the middle
panel.
This difference in the equilibrium positions of the two economies has important implications
for the volatility of the consumption of active households and therefore the equity premium. To
demonstrate this using our illustrative example, Figure 4 displays the effects of a deterministic
increase in technology on the equilibrium allocations implied by equations (31) and (32). An
increase in technology shifts the GM curve upward and to the right, as the economy’s resources
expand. The MR curve shifts to the right, as the wage income of non-rebalancers rises. This
boosts the consumption of non-rebalancers from cI0 to cI1 .
18
20. With the initial equilibrium occurring near the minimum of the parabola, there is a large
increase in the consumption of non-rebalancers that exceeds both the increase in non-rebalancer
consumption and technology. This large increase reflects that the technology shock, by raising
the return on equity, also involves a redistribution away from non-rebalancers to rebalancers.
While this redistribution occurs in the endogenous participation model, its effects on active
consumption are modest, given that the initial equilibrium is at a point at which the MR curve
is relatively steep.
An important implication of Figure 4 is that the consumption of rebalancers will be con-
siderably more volatile than the consumption of non-rebalancers and aggregate consumption,
if the fraction of rebalancers is relatively small. To demonstrate this, Figure 5 returns to the
benchmark calibration of the endogenous rebalancing model in which the fixed cost is normally
distributed. The upper panel displays that the probability of rebalancing is monotonically de-
creasing in a household’s fixed cost. Roughly ten percent of households will rebalance more
than 80 percent of the time, while more than 50 percent of the households do not reallocate
cash from asset to goods markets after making their initial non-state contingent allocation.
Thus, in line with the microdata, there is considerable heterogeneity in portfolio rebalancing,
with a large group of households exhibiting substantial inertia in their portfolio allocation.
The middle panel of Figure 5 displays the mean level of consumption for different types
of households. As suggested by our illustrative example involving the GM and MR curves,
households that rebalance more frequently have a slightly higher average level of consumption
than non-rebalancers. In addition, the consumption of a household that frequently rebalances its
portfolio is about four times more volatile than a household that keeps their portfolio unchanged
at its initial allocation. In effect, households that rebalance frequently are trading off higher
consumption volatility against a higher mean level of consumption.
This higher volatility of the consumption of rebalancers helps explain why the endogenous
rebalancing model can help account for the equity premium puzzle. In the standard CIA model,
the pricing kernel depends on aggregate consumption. While aggregate consumption growth
and the return on equity are positively correlated, the covariance between these variables is
19
21. small, reflecting the low volatility of aggregate consumption. In the endogenous rebalancing
model, the volatility of aggregate consumption growth is also low, but the pricing kernel depends
on the consumption of active rebalancers.
3.4 Monetary Policy and Equity Prices
In the endogenous rebalancing model, technology shocks account for roughly 80 percent of the
mean excess return on equity. Still, monetary policy shocks can induce important fluctuations
in equity prices and the equity premium. In this section, we investigate this relationship and
compare our model’s implications to the estimates of Bernanke and Kuttner (2005).
Using high-frequency data on the federal funds rate, Bernanke and Kuttner (2005) construct
a measure of unanticipated changes in monetary policy. They find that a broad index of stock
prices registers a one-day gain of 1 percent in reaction to a 25 basis point easing of the federal
funds rate. Building on the analysis of Campbell (1991) and Campbell and Ammer (1993),
Bernanke and Kuttner (2005) then use a structural VAR to decompose the response of stock
prices into three components: changes in current and expected future dividends, changes in
current and expected future real interest rates, and changes in expected future excess equity
returns or equity premia. While an unanticipated easing lowers interest rates, they conclude
that an important channel in which stock prices increase occurs through changes in the equity
premia or the perceived riskiness of stocks.
To compare our model’s implications to these stylized facts, we compute impulse response
functions from the endogenous rebalancing model. Since our model is nonlinear, it is important
to define how we construct these impulse responses. Follow the discussion in Hamilton (1994),
we define the impulse response of variable, y(st ), at date t to a monetary innovation that occurs
at date 1 as:
E[log y(st ) | µ1 , z0 ] − E[log y(st ) | µ0 , z0 ], ∀t ≥ 1, (33)
where µ0 = µ and z0 = z . Thus, an impulse response to a monetary shock occurring at date 1
¯ ¯
is defined as the revision in expectations from a variable’s unconditional mean. For log-linear
20
22. models, equation (33) simplifies to the usual analytical representation in which (up to a scaling
factor) the model’s linear coefficients characterize the impulse response function. Since in our
context evaluating the expectations in equation (33) involves multidimensional integrals, we
use Monte Carlo integration to compute the impulse response functions. The details of this
procedure are discussed in the appendix.
Figure 6 shows the impulse response to a monetary innovation that raises money growth a
quarter of a standard deviation at date 1. The solid blue lines in the figure show the results in
which money growth, as in Alvarez, Atkeson, and Kehoe (2007b), has an autocorrelation of 0.9,
and the dashed red line shows the results for our estimated autocorrelation of 0.68. Starting
with the blue line, the nominal interest rate falls about 100 basis points on impact, and the real
rate falls about 150 basis points. Thus, as the limited participation models of Lucas (1990) and
Fuerst (1992), our economy displays a significant liquidity effect. Moreover, as in AAK (2001),
this liquidity effect is persistent, as interest rates gradually rise back to their unconditional
means.
The unanticipated monetary expansion induces a significant increase in the price of equity.
Equity prices rise about 3 percent on impact, implying a multiplier of 3 from the 100 basis
point easing in monetary policy. Such a multiplier is in line with Bernanke and Kuttner (2005),
who estimate multipliers between 3 and 6, when they take into account sampling uncertainty.
On impact, the equity premium moves down 1.5 percentage points, and its response mirrors
that of equity prices. Dividends in our model are simply a function of technology and do not
change in response to the monetary innovation. Thus, the increase in stock prices reflects both
the fall in real rates and the decline in the risk premium, with these variables playing a roughly
equal role in accounting for the higher return on equity. Thus, our model is broadly consistent
with the evidence presented in Bernanke and Kuttner (2005).
Figure 6 also shows the response of consumption of rebalancers and non-rebalancers and
the fraction of rebalancers. A monetary injection has a redistributive effect, as it reduces the
consumption of non-rebalancers, whose real money balances available for consumption fall, and
raises the consumption of those that choose to rebalance. This redistributive effect induces
21
23. more households to rebalance and the fraction of rebalancers rises about 0.6 percentage points
on impact. In this regard, our model has a similar mechanism to Alvarez, Atkeson, and Kehoe
(2007b), but our focus is on the intensive margin (i.e., the frequency in which a household
uses a state contingent transfers rather than the non-state contingent transfer) rather than the
extensive margin (i.e., the participation rate in financial markets).
To understand why a monetary easing induces a decline in the equity premium, it is helpful
to revisit our illustrative example and consider the effect of a deterministic change in money
growth on the GM and MR schedules. The top panel of Figure 7 shows the effects of a small
positive increase in the money growth. This increase shifts the GM curve to the right, since
the consumption of rebalancers rises for a fixed γ . In addition, the lower consumption of the
¯
non-rebalancers (which occurs at the minimum of the parabola) shifts the MR curve upward
and to the left, implying that the benefit to making the state-contingent transfer has gone up.
Hence, the deterministic increase in money growth leads to an equilibrium with both higher
consumption of active rebalancers and a higher fraction of rebalancers.
With the increase in money growth occurring from an initial equilibrium close to the mini-
mum of the parabola, a small monetary expansion may induce a relatively large increase in the
consumption of rebalancers. However, this effect diminishes as the monetary shock becomes
larger, reflecting the concavity of the MR schedule. Near the initial equilibrium, small increases
in monetary policy induce relatively large increases consumption, while larger shocks lead to
smaller effects on consumption. Intuitively, as the shock becomes larger, a greater fraction of
households rebalance their portfolios, so that the nominal shock begins to have smaller and
smaller real effects.
Building on this intuition, the top two panels of Figure 8 show the first and second derivatives
of the logarithm of active consumption with respect to the logarithm of money growth in the
neighborhood of the unconditional mean for money growth. The top panel shows that the
∂ log cA (µt )
first derivative (i.e., ∂ log µt
) is positive and decreasing, reflecting that higher money growth
boosts active consumption but by progressively less. The middle panel shows that the second
derivative is increasing, reflecting the high degree of concavity of active consumption in the
22
24. neighborhood of the unconditional mean rate of money growth.
This nonlinearity drives the endogenous fluctuations in risk in our model. An increase
in money growth reduces the sensitivity of active consumption to expected future changes in
money growth, as the fraction of active rebalancers increases. Thus, for higher rates of money
growth, active consumption growth becomes less volatile and its covariance with the return on
equity diminishes, leading to a decline in the equity premium. The middle panel of Figure 7
also suggests that this logic holds in reverse for small monetary contractions. In particular,
a monetary contraction induces a relatively large decline in active consumption, with active
consumption becoming more volatile. With the return on equity also falling in response to a
monetary contraction, active rebalancers demand a higher risk premium on equity.
Another important nonlinearity in our model is that the fraction of rebalancers may actually
rise for a large enough contraction in money growth. This possibility is illustrated in the bottom
panel of Figure 7 which shows that the GM curve becomes an upward sloping function that
intersects the MR curve to the left of its minimum value. For large monetary contractions,
households real money balances are high and the cost of making the state-contingent transfer
becomes negative, since x = cA − cI < 0. Thus, more households choose to become active and
transfer funds into their brokerage accounts.
To illustrate that larger shocks induce a higher fraction of rebalancers, the bottom panel of
Figure 8 displays the regions of inactive and active rebalancing for the distribution of households
as a function of the deterministic rate of money growth. The blue line in the figure indicates the
marginal household, who is indifferent between keeping its cash portfolio unchanged and using
the state-contingent transfer. For larger shocks, whether positive or negative, more households
opt to become active and make use of their state contingent transfer.
4 Conclusions
We have developed a dynamic stochastic general equilibrium model in which monetary policy
affects the economy through its effect on risk premium. Our model can be viewed as an
23
25. extension of the neoclassical framework by incorporating segmentation between asset and goods
markets. In this sense, we hope to the next link in the chain beginning with Lucas (1990)
and recently extended by Alvarez, Atkeson, and Kehoe (2002). However, we depart from
the former in two important respects. First, we explicitly model a production economy with
equity returns. Second and more importantly, all households participate in financial markets
in our environment, but it is costly to make state contingent transfers between asset and
goods markets. In other words, our model emphasizes endogenous asset segmentation along an
intensive margin (i.e., portfolio rebalancing decision) rather than along the extensive margin
(i.e., participation decision).
This modification is consistent with micro evidence on the frequency of household portfolio
rebalancing. This evidence suggests that portfolio rebalancing occurs infrequently at the aggre-
gate level, though there is a great deal of heterogeneity at the micro level. This heterogeneity
in household’s portfolio allocation is the key mechanism through which the model is able to
account for the average excess returns on equity and endogenous movements in risk following a
monetary shock. In line with the evidence of Bernanke and Kuttner (2005), a monetary easing
can lead to a decline in equity premium, because more households choose to transfer funds
between asset and goods markets.
The mechanism described in this paper opens new interesting avenues for further research.
First, it is part of an ongoing effort to disentangle the direction of causality between risk and
monetary policy. Hence, allowing for feedback of changes in risk on to the policy instrument
might constitute an important extension of the model. Second, it would be natural to incorpo-
rate endogenous capital and labor supply into the model and examine whether the model can
account for key features of both asset prices and business cycles. Finally, it would be useful to
address how endogenous movements in risk affect the optimal design of monetary policy.
24
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26
28. Figure 1: Endogenous Rebalancing, Standard CIA Model, and the Equity Premium
12
Avg. Fraction of Rebalancers = 11% (γ =3.5%)
m
10
Avg. Fraction of Rebalancers = 15% (σ = 4)
8
Avg. Fraction of Rebalancers = 13% (γm=2%, σ=3)
Equity Premium (AR%)
U.S. Data
6
Avg. Fraction of Rebalancers = 24% (γm=0.5%)
Avg. Fraction of Rebalancers = 11% (σ = 2)
4
Standard CIA Model (σ = 15)
2
Standard CIA Model (σ = 3)
0
−1 −0.5 0 0.5 1 1.5 2 2.5 3 3.5 4
Risk−Free Rate (AR%)
27
34. Figure 7: A Deterministic Change in Money Growth in the Rebalancing Model
A Small Monetary Expansion
1
Fraction of Rebalancers
0.8
0.6 Final
Equilibrium
(µ >µ )
0.4 1 0
Initial
Equilibrium
0.2 (µ0)
0
0.9 0.95 1 1.05 1.1
Consumption of Rebalancers
A Small Monetary Contraction
1
Fraction of Rebalancers
0.8
Initial
0.6 Equilibrium
Final (µ0)
0.4
Equilibrium
(µ <µ )
0.2 1 0
0
0.9 0.95 1 1.05 1.1
Consumption of Rebalancers
A Big Monetary Contraction
1
Fraction of Rebalancers
0.8
Final Initial
0.6 Equilibrium Equilibrium
(µ1<<µ0) (µ0)
0.4
0.2
0
0.9 0.95 1 1.05 1.1
Consumption of Rebalancers
33
35. Figure 8: The Shape of Active Consumption and Regions of Active and Inactive Rebalancing
First Derivative of Consumption With Respect to Money Growth
3
2
1
0
0.007 0.01 0.012 0.014
Deterministic Level of Money Growth
Second Derivative of Consumption With Respect to Money Growth
0
−1000
−2000
−3000
0.007 0.01 0.012 0.014
Deterministic Level of Money Growth
Regions of Active and Inactive Rebalancing
Household Distribution (Percentile)
0.2
0.15
Inactive Region
0.1
Active Region
Active Region
0.05
0
−0.02 −0.01 0 0.01 0.02 0.03 0.04
Deterministic Level of Money Growth
34
36. Appendix
A Appendix
A.1 Sufficient Conditions for the Existence of an Equilibrium
In this Appendix, we provide sufficient conditions to ensure that households never carry over
cash in either goods market or the asset market. Our strategy closely follow the Appendix
in Alvarez, Atkeson, and Kehoe (2002). Hence we first modify the households constraints as
follows. We introduce in the cash-in-advance constraint the possibility that the household may
hold cash, a(st , γ) ≥ 0:
a(st , γ) = m(st , γ) + x(st , γ)z(st , γ) + A(γ) − c(st , γ), for all t ≥ 1
We also use the budget constraint to rewrite the money balances as as follows:
P (st )[w(st , γ) + a(st , γ)]
m(st , γ) = (A.1)
P (st+1 )
In the asset market, we replace the period by period constraint with the sequence of budget
constraints for t ≥ 1 :
B(st , γ) = q(st , st+1 )B(st+1 , γ)dst+1 +N (st , γ)−N (st−1 , γ)+P (st )[x(st , γ)+γ]z(st , γ) (A.2)
st+1
where N (st−1 , γ) is the cash held over from the previous asset market and N (st , γ) is cash held
over into the next asset market. At time t = 0, the initial wealth is distributed as follows:
B(γ) = q(s1 )B(s1 , γ)ds1 + PA A(γ) + N0
st+1
where N0 is independent from γ.
We now proceed to develop the sufficient conditions. First, in Lemma 1 we first characterize
the household’s optimal allocation of c and x, given prices and arbitrary rules for for m, a, and
z. Second, in Lemma 2, we characterize the the household trading rule z given arbitrary rules
for m and a–and the optimal rules specified in the Lemma 1. Finally, in Lemma 3 we provide
sufficient conditions on the money growth process to ensure that a and N are always zero.
We rewrite the asset market constraint recursively by substituting out bond holdings to
write a time t = 0 constraint as follows:
∞
B(γ)−N0 ≥ Q(st ) P (st )[x(st , γ) + γ]z(st , γ) + [N (st , γ) − N (st−1 , γ)] dst +PA A(γ)
t=1 st
35
37. (A.3)
where Q(st ) = t q(sj ) = q(s1 )q(s2 )..q(st ). Using the fact that N (st−1 , γ) ≥ 0 for all t ≥ 0,
j=1
then N0 .
The household problem can be restated as follows. Choose the m, a, z, c, x, and N , subject
to the constraints (A.1)-(A.3). Formally we form the following Lagrangian:
∞
M ax β t U [c(st , γ)]g(st )dst
t=1 st
∞
+ ν(st , γ)[m(st , γ) + x(st , γ)z(st , γ) + A(γ) − c(st , γ) − a(st , γ)]dst
t=1 st
∞
P (st )[w(st , γ) + a(st , γ)] t
+ κ(st , γ)[m(st , γ) − ]ds +
t=1 st P (st+1 )
∞
λ(γ) B(γ) − Q(st ) P (st )[x(st , γ) + γ]z(st , γ) + [N (st , γ) − N (st−1 , γ)] dst − PA A(γ)
t=1 st
where ν(st , γ), κ(st , γ), and λ(γ) represent the Lagrange multipliers of the constraints (A.1)-
(A.3), respectively.
The first order conditions for c, x, and A(γ):
β t U [c(st , γ)]g(st ) = ν(st , γ)
ν(st , γ)z(st , γ) − λ(γ)Q(st )P (st )z(st , γ) = 0
Let suppose that z(st , γ) = 1 for some state of the world st :
β t U [c(st , γ)]g(st ) = λ(γ)Q(st )P (st )
We assume an initial wealth B(γ), such that λ(γ) = λ, for all γ. This assumption implies that
B(γu ) > B(0), i.e. that after t = 0, once the agents have decided the annuity, all the agents
have the same wealth.
Lemma 1. All households that choose to pay the fixed cost (i.e. z(st , γ) = 1) for a given
aggregate state st have identical consumption c(st , γ) = cA (st ). Thus,
x(st , γ) = cA (st , γ) − a(st , γ) − m(st , γ) + A(γ) (A.4)
Househods that choose not to pay the fixed cost (i.e. z(st , γ) = 0) have consumption equal to:
c(st , γ) = cI (st , γ) = m(st , γ) − a(st , γ) + A(γ) (A.5)
We next consider a household’s optimal choice of whether to pay the fixed costs to trade,
given prices Q(st ), P (st ), and PA , for arbitrary choices for m and a. From Lemma 1 we have
the form of the optimal allocation for c and x corresponding to the choices of z(st , γ) = 1
36
38. and z(st , γ) = 0. Substituting this rules into the utility function and the constraint (A.3)
characterizes the problem of choosing z(st , γ) and cA (st , γ):
∞ ∞
t t t t t
β U [cA (s )]z(s , γ)g(s )ds + β t U [m(st , γ) + A(γ) − a(st , γ)](1 − z(st , γ))g(st )dst
t=1 st t=1 st
∞
P (st )[cA (st )+γ-(m(st , γ)+A(γ)-a(st , γ))]z(st , γ)
+η(γ) B(γ)- Q(st ) dst -PA A(γ)
st +[N (st , γ)-N (st−1 , γ)]
t=1
We use a variational argument to characterize the optimal choice of z(st , γ). The increment to
the Lagrangian of setting z(st , γ) = 1 in the state of the world st and for a given cost γ,
β t U [cA (st )]g(st ) − η(γ)Q(st )P (st )[cA (st )+γ-(m(st , γ)+A(γ)-a(st , γ))]dst (A.6)
which corresponds to the difference between the utility gain minus the cost of transfering funds.
The increment to the Lagrangian of setting z(st , γ) = 0 in the state of the world st and for a
given cost γ,
β t U [m(st , γ) + A(γ) − a(st , γ)](1 − z(st , γ))g(st ) (A.7)
which, in the absence of transfers, it corresponds to the direct utility. The first order condition
with respect to cA (st , γ) is given by:
β t U [cA (st )]g(st ) = η(γ)Q(st )P (st ),
from which it follows η(γ) = η. Subtracting (A.7) from (A.6) and using the first order conditions
with respect to cA (st ), we can define the following function h(st , γ, A(γ)):
U [cA (st )] − U [m(st , γ) + A(γ) − a(st , γ)]
h(st , γ, A(γ)) = β t g(st ),
−U [cA (st )][cA (st ) + γ − (m(st , γ) + A(γ) − a(st , γ))]
that can be used to determined the cutoff value for γ.
We also need to characterize the annuity A(γ). The first order conditions for A(γ):
∞ ∞
t t t t t t
β U [m(s , γ)+A(γ)-a(s , γ)](1-z(s , γ))g(s )ds = ηPA - Q(st )P (st )z(st , γ)dst ,
t=1 st t=1 st
which can be rewritten as follows:
∞ ∞
ηPA = U [cA (st )]z(st , γ)g(st )dst + β t U [m(st , γ)+A(γ)-a(st , γ)](1-z(st , γ))g(st )dst
t=1 st t=1 st
This conditions is satisfied for all γ. We now assume that there will exist a γ ∈ [0, γM in ]. For
all these type of consumers, it follows:
∞
ηPA = U [cA (st )]z(st , γ)g(st )dst
t=1 st
37
39. which leaves A(γ) indeterminate. Substituting this expression into the previous first order
condition for γ > γM in , we have
∞
U [cA (st )] − U [m(st , γ) + A(γ) − a(st , γ)] (1 − z(st , γ))g(st )dst = 0,
t=1 st
which pins down the function A(γ). We will now assume that A(γ) is a non-negative non-
decreasing function. Under this assumption, we can show that there is a unique cutoff value
γ(c(st ), st ) such that:
h(st , γ, A(γ)) = 0
Formally, this means that a household chooses z(st , γ) = 0 if and only if γ > γ(c(st ), st ).
The proof straightforwardly follows from noticing that h(st , γ, A(γ)) is a strictly decreasing
function in γ. We will check that this condition is satisfied once we solve the model (see the
main text).
Consider now the market clearing condition for the annuity. Agents with γ > γM in choose
A(γ) and we will assume that households facing costs γ ≤ γM in will choose the same annuity
A such that:
γu
γM in 1
AM in = − A(γ)dγ
γu γu γM in
We now solve for the Lagrangian multiplier λ consitent with and equilibrium in which N (st , γ) =
0, for all st and γ. In this case, the multiplier λ satisfies expression (A.3) as an equality:
∞
−1 w(st−1 )
B(γ) − PA A(γ) = λ U [cA (st ) + γ − − A(γ)]dst
t=1 st µ(st−1 )
where
∞
1 AM in if γ≤γM in
PA = U [cA (st )]g(st )dst , A(γ) = {A(γ) if γu ≤γ≤γM in
λ t=1 st
Notice that the multiplier has the following expression:
∞ w(st−1 )
t=1 st
U [cA (st ) + γ − µ(st−1 )
− A(γ)]dst
λ=
B(γ) − PA A(γ)
To satisfy that λ does not depend upon γ, we need to allocate initial assets so that the
condition is satisfied. We can also normalize B(γ) so that λ = 1. This non-zero value of the
multiplier implies that the financial constraint is binding with N (st , γ) = 0 for all st . For this
to be true, it must be the case that the nominal interest rate is always positive, i(st ) > 0.
38
40. A.2 Solving the Model
[To be completed]
A.3 Computation of Impulse Responses
[To be completed]
39