the replacement problem abstract a prototypical vintage capital model of economic growth is developed where the decision to replace old technologies with new ones is modeled explicitly technological change is investment specific depreciation in this environment is an economic not a physical concept the vintage capital economy s balanced growth paths and transitional dynamics are analyzed the transitional dynamics are markedly different from the standard neoclassical growth model

the opportunity cost of mean variance choice under estimation risk abstract mean variance portfolio choice is often criticized as sub optimal in the more general expected utility framework it is argued that the expected utility framework takes into consideration higher moments ignored by mean variance analysis a body of research suggests that mean variance choice though arguably sub optimal provides very close to expected utility maximizing portfolios and their expected utilities basing its evaluation on in sample analysis where mean variance choice is sub optimal by definition in order to clarify this existing research this study provides a framework that allows comparing in sample and out of sample performance of the mean variance portfolios against expected utility maximizing portfolios our in sample results confirm the results of earlier studies on the other hand our out of sample results show that the expected utility model performs worse the out of sample inferiority of the expected utility model is more pronounced for preferences and constraints under which in sample mean variance approximations are weakest we argue that in addition to its elegance and simplicity the mean variance model extracts more information from sample data because it uses the covariance matrix of returns the expected utility model may reach its optimal solution without using information from the covariance matrix

capital utilization and habit formation in a small open economy model this paper shows the effects of endogenous capital utilization and habit formation in consumption on the predictions of a small open economy model calibrated to canada capital utilization improves the fit of the model by increasing the volatility of output investment and hours worked while habit formation improves the fit of the model by improving the dynamic properties of consumption and the current account it is also shown that while shocks to the world interest rate sometimes improve the fit of the baseline model they do not improve the fit of the model with capital utilization and habit formation jel classification e32 f32 utilisation du capital et formation d habitudes dans un modele de petite economie ouverte ce memoire etudie les effets de l utilisation endogene du capital et de la formation d habitudes de consommation sur les previsions d un modele de petite economie ouverte calibre pour le canada l utilisation du capital ameliore l ajustement du modele en accroissant la volatilite de l output de l investissement et des heures travaillees alors que la formation d habitudes ameliore l ajustement du modele en ameliorant les proprietes dynamiques de la consommation et du compte courant on montre que si des chocs affectant les taux d interet au niveau mondial ameliorent parfois l ajustement du modele de base ils n ameliorent pas l ajustement du modele quand il y a utilisation de capital et formation d habitudes

a tale of two regimes theory and empirical evidence for a markov modulated jump diffusion model of equity returns and derivative pricing implications abstract we provide closed form solutions for a continuous time markov modulated jump diffusion model in a general equilibrium framework for options prices under a variety of jump diffusion specifications we further demonstrate that the two state model provides the leptokurtic return features volatility smile and volatility clustering observed empirically for the dow jones industrial average djia and its component stocks using 10 years of stock return data we confirm the existence of jump intensity switching and clustering illustrate transition probabilities and verify superior empirical fit over competing poisson style models

dynamic inefficiency endogenous growth and ponzi games we show that in competitive endogenous growth models without externalities balanced growth equilibria are dynamically efficient with learning by doing externalities dynamic inefficiency may exist but due to the mix of capital rather than its scale these results are obtained independent of whether or not lifetimes are finite or generations overlap in olg models with externalities we show that ponzi games may be feasible even though equilibria are characterized by undersaving

investment specific shocks and external balances in a small open economy model we set up a standard small open economy business cycle model driven by govern ment spending shocks neutral productivity tfp shocks and investment specific shocks the model is calibrated to quarterly canadian data and its predicted moments and sample paths are compared with their canadian counterparts we find that the model captures the dynamics in investment and in the trade balance better than special cases of the model where either one of the productivity shocks is omitted more specifically the model matches the variance of the trade balance output ratio its correlation with output and its autocorrelation it also matches the output investment correlation jel classification f41 e32

optimal fiscal policy in a business cycle model with public capital in this paper a real business cycle model with optimal tax rates government borrowing and productive public capital is analysed a specification that allows for multiple stochastic shocks to technology and preferences can reproduce some key features describing the cyclical behaviour of postwar u s fiscal policy the optimally chosen policy variables fluctuate substantially over the business cycle but they do not operate like automatic stabilizers jel classification e62 e32 politiquefiscale optimale dans un modee de cycle d affaires avec capital public ce m6moire analyse un modele de cycle d affaires r6el avec taux d imposition optimaux emprunts gouvernementaux et capital public productif une sp6cification de ce modele qui enregiste plusieurs chocs stochastiques affectant technologie et pr6f6rences peut reproduire quelquesunes des caract6ristiques d6crivant le comportement cyclique de la politique fiscale d apres guerre des etats unis les variables correspondant a la politique optimale choisie fluctuent substantiellement au cours du cycle mais n operent pas comme des stabilisateurs automatiques

exploring the sources of default clustering abstract we study the sources of corporate default clustering in the united states we reject the hypothesis that firms default times are correlated only because their conditional default rates depend on observable and latent systematic factors by contrast we find strong evidence that contagion through which the default by one firm has a direct impact on the health of other firms is a significant clustering source the amount of clustering that cannot be explained by contagion and firms exposure to observable and latent systematic factors is insignificant our results have important implications for the pricing and management of correlated default risk

growth dynamics and education spending the role of inherited tastes and abilities we present an overlapping generations model with endogenous growth in which children inherit human capital and standard of living aspirations from the previous generation adults evaluate their own consumption with respect to a baseline requirement which depends on their parents past consumption the interaction between these two intergenerational externalities leads to rich dynamics first starting with too high aspirations or with too low human capital will conduct the economy into a poverty trap second the growth rate and the savings rate are characterized by oscillations third a repelling cycle may delimit a basin of attraction around the balanced growth path this may lead countries starting with too high human capital to a boom followed by an irreversible decline c 2001 elsevier science b v all rights reserved

partial information about contagion risk self exciting processes and portfolio optimization abstract this paper compares two classes of models that allow for additional channels of correlation between asset returns regime switching models with jumps and models with contagious jumps both classes of models involve a hidden markov chain that captures good and bad economic states the distinctive feature of a model with contagious jumps is that large negative returns and unobservable transitions of the economy into a bad state can occur simultaneously we show that in this framework the filtered loss intensities have dynamics similar to self exciting processes besides we study the impact of unobservable contagious jumps on optimal portfolio strategies and filtering

leverage effect volatility feedback and self exciting market disruptions equity index volatility variation and its interaction with the index return can come from three distinct channels first index volatility increases with the market s aggregate financial leverage second positive shocks to systematic risk increase the cost of capital and reduce the valuation of future cash flows generating a negative correlation between the index return and its volatility regardless of financial leverage finally large negative market disruptions show self exciting behaviors this article proposes a model that incorporates all three channels and examines their relative contribution to index option pricing and stock option pricing for different types of companies

location scale portfolio selection with factor recentered skew normal asset returns abstract this paper analyzes the single period portfolio selection problem on the location scale return family the skew normal distribution after recentering and reparameterization is shown to be in this family the recentered and reparameterized distribution called factor recentered skew normal can be expressed as a skew factor model which is characterized by a location parameter and two scale parameters risk preference on scale parameter is non monotonic and risk averse investors prefer larger smaller scale when the scale is negative positive the three parameter efficient set is a part of conical surface bounded by two lines positive skewness portfolios and negative skewness portfolios do not coexist in the efficient set numerical cases under constant absolute risk aversion are analyzed with its closed form certainty equivalent an asset pricing formula which nests the capm is obtained

international real business cycles among heterogeneous countries abstract business cycle statistics differ widely across countries for some aggregates especially for trade related variables part of these variations relates to the size of the economies and to their distance from each other this paper asks whether a three country model is able to display the marked diversity of business cycle statistics observed across countries the model is calibrated to two specific examples canada and switzerland our findings are that most of the diversity of the business cycles can be accounted for by size and distance and that trade is not a strong channel of diffusion of cycles

functional equivalence between intertemporal and multisectoral investment adjustment costs abstract two types of adjustment cost specifications coexist in macroeconomic models with investment intertemporal adjustment costs which involve a nonlinear substitution between capital and investment in capital accumulation and multisectoral costs which are captured by a nonlinear transformation between consumption and investment this paper demonstrates a functional equivalence between these two specifications one surprising result is that an increase in multisectoral adjustment costs can be equivalent to a decrease in intertemporal adjustment costs depending upon the size of the intertemporal costs we then observe that the functional equivalence implies a problem in identifying the two types of adjustment costs and show ways to solve the problem

real exchange rates preferences and incomplete markets evidence 1961 2001 many international macroeconomic models link the real exchange rate to a ratio of marginal utilities we examine this link empirically allowing the marginal utility of consumption to depend on government expenditure real money balances or external habit we also consider two environments with incomplete asset markets one with exogenously missing markets but an endogenous discount rate that anchors the distribution of wealth and one with endogenous market segmentation although none of these satisfies theoretical and over identifying restrictions for every country utility with external habit persistence provides the best match with real exchange rates for oecd countries between 1961 and 2001 jel classification f41 taux de change reels preferences et marches incomplets resultats 1961 2001 plusieurs modeles macroeconomiques internationaux lient le taux de change reel a un ratio des utilites marginales on examine ce lien empiriquement en permettant a l utilite marginale de la consommation de dependre des depenses du gouvernement des encaisses monetaires reelles ou des habitudes donnees on considere aussi deux environnements avec des marches incomplets pour les actifs l un avec des marches exogenes manquants mais un taux d escompte endogene qui ancre bien la repartition des revenus et l autre avec des marches segmentes endogenes bien que ni l un ni l autre ne satisfasse les imperatifs theoriques et les restrictions sur identifiees pour chaque pays l utilite avec les persistances d habitudes externes engendre l ajustement le meilleur avec les taux de change reels des pays de l ocde entre 1961 et 2001

accommodating diverse institutional investment objectives and constraints using non linear goal programming abstract institutional portfolio managers face a diverse mix of conflicting investment objectives and constraints such as risk and retum goals institutional liability considerations fund management legal restrictions institutional cash flow requirments and protfolio management performance targets this paper argues that lexicographic goal programming can be used to keep track of an institution s complex investment goals and will provide a best possible solution for the institution s portfolio selection problem three examples illustrate the applicability of non linear goal programming to institutions differing investment requirements

fixed and variable rate mortgages business cycles and monetary policy the aim of this paper is twofold first i study how the proportion of xed and variable rate mortgages in an economy can aect the way shocks are propagated second i analyze optimal implementable simple monetary policy rules and the welfare implications of this proportion i develop and solve a new keynesian dynamic stochastic general equilibrium model that features a housing market and a group of constrained individuals who need housing collateral to obtain loans a given proportion of constrained households borrows at a variable rate while the rest borrows at a xed rate the model predicts that in an economy with mostly variable rate mortgages an exogenous interest rate shock has larger eects on borrowers than in a xed rate economy aggregate eects are also larger for the variable rate economy for plausible parametrizations dierences are muted by wealth eects on labor supply and by the presence of savers more persistent shocks such as in ation target and technology shocks cause larger aggregate dierences from a normative perspective i nd that in the presence of collateral constraints the optimal taylor rule is less aggressive against in ation than in the standard sticky price model furthermore for given monetary policy a high proportion of xed rate mortgages is welfare enhancing

cyclical correlations credit contagion and portfolio losses abstract we model aggregate credit losses on large portfolios of financial positions contracted with firms subject to both cyclical default correlation and direct default contagion processes cyclical correlation is due to the dependence of firms on common economic factors contagion is associated with the local interaction of firms with their business partners we provide an explicit normal approximation of the distribution of portfolio losses we quantify the relation between the variability of global economic fundamentals strength of local firm interaction and the fluctuation of losses we find that cyclical oscillations in fundamentals dominate average losses while local interaction causes additional fluctuations of losses around their average the strength of the contagion induced loss variability depends on the complexity of the business partner network

the transition from dirty to clean industries optimal fiscal policy and the environmental kuznets curve abstract this paper investigates privately and socially optimal patterns of economic development in a two sector endogenous growth model with clean and dirty goods we consider a second best fiscal policy framework in which distortionary taxes jointly influence economic growth and environmental quality in this policy setting three conditions produce an environmental kuznets curve ekc i dirty output is bounded ii clean output grows endogenously and iii growth in the dirty sector reduces growth in the clean sector these conditions do not arise with a consumption externality but can emerge with a production externality endogenous labor supply implications are also investigated although not necessary for producing an ekc endogenous labor supply provides additional linkages that produce an ekc under circumstances in which it would otherwise not appear

labor supply in the past present and future a balanced growth perspective the absence of a trend in hours worked in the postwar united states is an exception across countries and historically hours fall steadily by a little below 0 5 per year are steadily falling hou

on the distributional conditions for a consumption oriented three moment capm in this paper we develop sufficient conditions on probability distributions for a three moment mean variance and skewness consumption oriented capital asset pricing model capm to price correctly a subset of assets the assumptions that individuals in an allocationally efficient capital market have identical probability beliefs and monotone increasing strictly concave utility functions displaying nonincreasing absolute risk aversion imply an aggregate preference function that exhibits preference for expected return aversion to variance of return and preference for positive skewness for otherwise arbitrary preferences we show that quadratic characteristic lines are sufficient for a subset of assets to be priced according to a three moment consumption oriented capm

real and nominal propagation of nominal shocks the role of real and nominal propagation mechanisms in generating persistent real effects of nominal shocks is analysed analytically in a fully specified intertemporal general equilibrium model while neither a real propagation mechanism capital acccumulation with one period nominal contracts nor nominal propagation staggered nominal contracts in the absence of any real propagation can generate plausible impulse responses with strong persistence it is shown that the two mechanisms interact so as to strengthen persistence possibly unit roots and generate more plausible impulse responses

spectral and persistence properties of cyclical growth abstract this article investigates the cyclical properties of an endogenous growth model an explicit solution is derived which permits the full characterization of the cyclical as well as the long run properties of the model using spectral autocorrelation and impulse response functions we show that introducing endogenous growth overcomes some of the main shortcomings of rbc models in particular the model can generate positive autocorrelation of output growth when endogenous growth dominates the dynamics moreover the model exhibits the hump shaped pattern of impulse response functions of the trend reverting component of output

time changed levy processes and option pricing abstract the classic black scholes option pricing model assumes that returns follow brownian motion but return processes differ from this benchmark in at least three important ways first asset prices jump leading to non normal return innovations second return volatilities vary stochastically over time third returns and their volatilities are correlated often negatively for equities time changed levy processes can simultaneously address these three issues we show that our framework encompasses almost all of the models proposed in the option pricing literature and it is straightforward to select and test a particular option pricing model through the use of characteristic function technology

wars and capital destruction abstract in this paper we propose a theoretical framework to investigate the impact of conflicts and wars on key macroeconomic aggregates and welfare using a panel data with 9 countries from 1870 onwards we first show that the consumption to output ratio is minimal during wwii for participants while this can be explained by an increase in public spending in the usa this cannot be the case in other countries that participated in wwii as they experience a large fall in output during wartime to account for this we build a variation of a real business cycle model first proposed by hercowitz and sampson 1991 we extend the initial model to account for specific shocks that destroy private and public capital stocks as conflicts do by assuming an exogenously time varying parameter in the law of capital accumulation in addition the model imbeds generalized tfp shocks capturing standard technological factors as well as the potential effects of war on the labor force the model is estimated and used i to assess the importance of capital shocks during war episodes and ii to quantify the welfare effects of conflicts we show that capital shocks are crucial to account for the macroeconomic dynamics of countries that have experienced large war related destruction and that the welfare losses from fluctuations can be quite large when considering data samples that include major war episodes

output growth the real wage and employment fluctuations this paper is an attempt to contribute to the integration of business cycle analysis with long term growth a real business cycle model with endogenous growth is developed and estimated with u s data in the present framework wage movements do not have to be transitory to generate fluctuations in labor effort the reduced form is a constrained bivariate output hours or real wage hours vector autoregressive process the bivariate setup provides a useful framework for analyzing the persistence of output fluctuations given that the theory implies that hours of work contain information about future output movement copyright 1991 by american economic association

factor pricing in a finite economy abstract prior theoretical derivations of the arbitrage pricing theory apt bound an aggregate measure of the deviation of mean asset returns from that predicted by a linear pricing equation it is conceivable given this bound that some assets might be badly mispriced by the model in this paper a more intuitive derivation of the factor pricing equation is presented which describes the deviation on an asset by asset basis the deviation is shown to be small for assets in a realistic finite economy and is arbitrarily close to zero for those assets with arbitrarily small size relative to aggregate wealth it follows that the linear pricing equation provides a good approximation for the mean returns of all traded assets

credit contagion in a network of firms with spatial interaction this contribution studies the effects of credit contagion on the credit risk of a portfolio of bank loans to this aim we introduce a model that takes into account the counterparty risk in a network of interdependent firms that describes the presence of business relations among different firms the location of the firms is simulated with probabilities computed using an entropy spatial interaction model by means of a wide simulation analysis we investigate the behavior of the model proposed and study the effects of default contagion on the loss distribution of a portfolio of bank loans

time changed birth processes and multiname credit derivatives a credit investor such as a bank granting loans to firms or an asset manager buying corporate bonds is exposed to correlated corporate default risk a multiname credit derivative is a financial security that allows the investor to transfer this risk to the credit market in this paper we study the valuation and risk analysis of multiname derivatives to capture the complex economic phenomena that drive the pricing of these securities we introduce a time changed birth process as a probabilistic model of correlated event timing the self exciting property of a time changed birth process captures the feedback from events that is often observed in credit markets the stochastic variation of arrival rates between events captures the exposure of firms to common economic risk factors we derive a closed form expression for the distribution of a time changed birth process and develop analytically tractable pricing relations for a range of multiname derivatives valuation problems we illustrate our results by calibrating a tranche forward and option pricer to market rates of index and tranche swaps

inflation variability and the evolution of human capital in a model with transactions costs abstract in a monetary growth model i show that average inflation inhibits growth while inflation volatility enhances it the effect of nominal volatility on human capital accumulation depends on the response of money demand and the corresponding extent of transactions costs rather than from a direct precautionary motive

money and output a test of reverse causation this paper attempts to explain the correlation between money and output at various leads and lags with a model in which money is largely neutral and endogenously responds to output money is endogenous because both monetary policy and deposit creation are endogenous parameters are selected according to the simulated moments estimation technique while the estimated model succeeds along some dimensions in matching properties of postwar u s data its failure to match key patterns of lead lag correlations seems to cast doubt on the ability of endogenous money determination by itself to quantitatively account for the observed money output correlations copyright 1996 by american economic association

optimal fiscal policy public capital and the productivity slowdown abstract this paper develops a quantitative theoretical model for the optimal provision of public capital we show that the ratio of public to private capital in the us economy since 1925 evolves in a manner that is broadly consistent with an optimal transition path derived from a simple growth model the model is used to quantify the conditions under which an increase in the stock of public capital is desirable and to investigate the degree to which nonoptimal fiscal policies can account for the us productivity slowdown

international risk sharing and economic growth international risk sharing which diversifies away income risk will reduce saving with constant relative risk aversion if growth arises from the external effects of human capital accumulation then reducing saving will reduce growth welfare also may fall with risk sharing because endogenous growth with external effects of capital accumulation typically implies a competitive equilibrium growth rate already less than the optimal growth rate we demonstrate these results in a standard representative agent economy diversifying away rate of return risk also will reduce saving and growth rates if relative risk aversion exceeds one but this diversification always increases welfare this paper studies the effects of international risk sharing portfolio diversification in a world economy in which growth rates of income are endogenous growth is based upon the spillover effects of human capital accumulation as in lucas 1988 and romer 1986 there are positive economy wide spillovers of human capital intensity on individual labour productivity in section 2 we construct a multi country growth model with an infinitely lived representative agent in each country each country faces income risk but there is no aggregate uncertainty at the world level we focus on two market structures in the first structure there are no markets which allow for international diversification of country specific income risk in the second structure there are complete international markets for risksharing with no aggregate world uncertainty this completeness allows full diversification of country specific risk the paper has two central results first growth rates in all countries are lower in the equilibrium with full diversification second in this same structure welfare of each country may be lower than in an equilibrium without risk sharing the reasoning is as follows with external effects of capital accumulation the compet

a new approach to test the effects of decentralization on public infrastructure investment this paper proposes a simple theoretical framework to obtain a tractable equation that considers the traditional criteria for allocating public infrastructure investment and variables to capture de

portfolio selection and asset pricing three parameter framework idiosyncratic security risks are modelled as following a joint spherical distribution characterized by a mean vector and a generalized covariance matrix skewness is generated by a single factor for the whole economy but upon which different securities have different loadings this results in three fund separation two funds to span the spherical risk and one more fund to span the additional skewness risk a three parameter normative portfolio analysis that allows short sales restrictions is developed in addition a three parameter capital asset pricing model is provided

inflation human capital and tobin s q a pervasive empirical finding for the us economy is that inflation is negatively correlated with the normalized market price of capital tobin s q and growth a dynamic stochastic general equilibrium model of endogenous growth is developed to explain these stylized facts in this model human capital is the principal driver of self sustained growth long run comparative statics analysis suggests that inflation diverts scarce time resource to leisure which lowers human capital utilization this impacts growth adversely and modulates capital adjustment cost downward resulting in a decline in tobin s q for the short run a tobin effect of inflation on growth weakens the negative association between inflation and q

stock prices and fundamentals a macroeconomic perspective this paper compares the predictions for the market value of firms from the gordon growth model with those from a dynamic general equilibrium model the predictions for movements in the market value of firms following shifts in preferences growth prospects and risk are quantitatively and qualitatively different across the models while previous research illustrated how a drop in the required return or an increase in the growth rate of the economy can explain the run up in equity values in the 1990s in the gordon growth model the general equilibrium model suggests that such results are misleading

common failings how corporate defaults are correlated we test the doubly stochastic assumption under which firms default times are correlated only as implied by the correlation of factors determining their default intensities using data on u s corporations from 1979 to 2004 this assumption is violated in the presence of contagion or frailty unobservable explanatory variables that are correlated across firms our tests do not depend on the time series properties of default intensities the data do not support the joint hypothesis of well specified default intensities and the doubly stochastic assumption we find some evidence of default clustering exceeding that implied by the doubly stochastic model with the given intensities why do corporate defaults cluster in time several explanations have been explored first firms may be exposed to common or correlated risk factors whose co movements cause correlated changes in conditional default probabilities second the event of default by one firm may be contagious in that one such event may directly induce other corporate failures as with the collapse of penn central railway in 1970 third learning from default may generate default correlation for example to the extent that the defaults of enron and worldcom revealed accounting irregularities that could be present in other firms they may have had a direct impact on the conditional default probabilities of other firms our primary objective is to examine whether cross firm default correlation that is associated with observable factors determining conditional default probabilities the first channel on its own is sufficient to account for the degree of time clustering in defaults that we find in the data

credit risk model with contagious default dependencies affected by macro economic condition abstract we consider a credit risk model with two industrial sectors where defaults of corporations would be influenced by two factors the first factor represents the macro economic condition which would affect the default intensities of the two industrial sectors differently the second factor reflects the influences of the past defaults of corporations against other active corporations where such influences would affect the two industrial sectors differently a two layer markov chain model is developed where the macro economic condition is described as a birth death process while another markov chain represents the stochastic characteristics of defaults with default intensities dependent on the state of the birth death process and the number of defaults in two sectors although the state space of the two layer markov chain is huge the fundamental absorbing process with a reasonable state space size could capture the first passage time structure of the two layer markov chain thereby enabling one to evaluate the joint probability of the number of defaults in two sectors via the uniformization procedure of keilson this in turn enables one to value a variety of derivatives defined on the underlying credit portfolios in this paper we focus on a financial product called cdo and a related option

an explicit bound on individual assets deviations from apt pricing in a finite economy abstract ross s arbitrage pricing theory apt is a tractible and reasonable alternative to the mean variance model nonetheless understanding of the theory has been obscured by the complexity of the sequence economy models used for motivation by contrast we give a simple and direct derivation of the apt in a finite economy using an explicit bound on the deviations from apt prices across assets a coarse calculation shows that theoretical deviations from apt pricing are negligible in our economy

the welfare cost of monopolistic competition revisited abstract this paper quantifies the welfare cost of monopolistic competition in a human capital based endogenous growth model with analytical solution for conservative calibrations it is shown that this welfare cost may be 2 of consumption well beyond conventional estimates

asset pricing under the quadratic class we identify and characterize a class of term structure models where bond yields are quadratic functions of the state vector we label this class the quadratic class and aim to lay a solid theoretical foundation for its future empirical application we consider asset pricing in general and derivative pricing in particular under the quadratic class we provide two general transform methods in pricing a wide variety of fixed income derivatives in closed or semi closed form we further illustrate how the quadratic model and the transform methods can be applied to more general settings i introduction we identify and characterize a class of term structure models where bond yields are quadratic functions of the markov process we label this class the quadratic class and aim to lay a solid theoretical foundation for its future empirical application we identify the necessary and sufficient conditions for the quadratic class and consider the general asset pricing problem under the quadratic framework in particular we propose two transform methods to price a wide variety of interest rate derivatives in closed or semi closed form we further illustrate how the pricing methods can be applied to more general settings examples include option pricing for currencies or stocks with quadratic stochastic volatilities our interests in the quadratic class come mainly from concerns on empirical application recent empirical research within the affine framework of duffie and kan 1996 indicates an inherent tension between i delivering good empirical performance in matching salient features of the interest rate data and ii excluding positive probabilities of having negative interest rates for example backus telmer and wu 1999 and dai and singleton 2000 find that incorporating gaussian state variables in the affine framework significantly increases the flexibility for model design and greatly improves its empirical performance in capturing the conditional dynamics of interest rates dai and singleton 2001

estimation risk in portfolio selection the mean variance model versus the mean absolute deviation model konno and yamazaki konno h k yamazaki 1992 mean absolute deviation portfolio optimization model and its applications to tokyo stock market management sci 39 519 531 propose the mean absolute deviation mad model as an alternative to the mean variance mv model they claim it retains all the positive features of the mv model saves the investor computing time and does not require the covariance matrix this paper shows that ignoring the covariance matrix results in greater estimation risk that outweighs the benefits in both models estimation error is more severe in small samples small observations relative to the number of assets and for investors with high risk tolerance the mv model s lower estimation risk is most striking in small samples and for investors with a low risk tolerance

realistic cross country consumption correlations in a two country equilibrium business cycle model abstract a well known feature of one good multi agent arrow debreu economies with edentical additively separable homothetic preferences is that the consumptions of all agents are perfectly correlated such economies are widely used in interpreting business cycles but seem to be inconsistent with observed cross country correlations of aggregate consumption this paper provides an example of a two country real business cycle model in which preferences are not separable between consumption and labor supply the model has a simple closed form solution closed form solution and allows for fluctuations in labor supply in equilibrium moreover it generates correlations between national consumption rates which are close to some of those observed in historical data jel f41

growth effects of shifting from a graduated rate tax system to a flat tax i introduction recently the debate concerning fundamental u s tax reform has led to a number of proposals that involve a shift toward a consumption based system 1 one such proposal is the so called flat tax of hall and rabushka 1995 the flat tax would apply a single tax rate to all labor income above a given threshold and to all capital income after fully expensing investment expenditures hall and rabushka 1995 argue that the adoption of their proposal would provide an enormous boost to the u s economy by dramatically improving incentives to engage in productive activities and would save taxpayers hundreds of billions of dollars in compliance and administration costs 2 in this article we develop a quantitative general equilibrium model to assess the growth effects of adopting a flat tax plan similar to the one proposed by hall and rabushka 1995 the model captures many of the features of the current u s tax code such as graduated personal tax rates a standard personal deduction separate tax rates applied to personal and business income double taxation of business income and differential tax treatment of physical and human capital under appropriate parameter settings the model can exhibit either endogenous or exogenous long run growth our choice of functional forms facilitates a closed form solution to the model this allows us to characterize explicitly the economy s transition path following the reform a central issue in the debate over fundamental tax reform is the effect that such a reform would have on economic growth the present analysis builds on the work of stokey and rebelo 1995 who use an endogenous growth framework to identify the key model features and parameters that are important for determining the quantitative impacts of distortionary taxes on long run growth 3 our study differs from theirs and the bulk of the dynamic tax literature in one fundamental respect here we evaluate the growth effects of shifting from a graduatedrate tax system to a flat rate system stokey and rebelo 1995 consider only flat rate systems in which the marginal tax rate is equal to the average tax rate we approximate the graduated rate tax system in the u s economy by an empirical tax rate function that allows the personal tax rate to depend positively on household taxable income in equilibrium household decisions are influenced by both the level and slope of the tax schedule to implement the flat tax reform we shift the parameters of the tax rate function to flatten the marginal tax schedule while maintaining revenue neutrality our methodology treats the hall rabushka proposal as one that in effect moves a representative household from one tax rate schedule to another we view this setup as a reasonable approximation to gauge the growth effects of tax reform at the macro level a more elaborate setup would of course allow for household heterogeneity at a given point in time in this regard we note that caucutt et al 2003 have recently examined the growth effects of graduated rate taxes in a two period overlapping generations model that includes both skilled and unskilled agents in their model a flatter tax schedule increases the fraction of skilled agents in the economy the share of total output devoted to education rises accordingly and the economy s long run growth rate is observed to increase the quantitative implications of their model are difficult to compare to ours however because their two period framework implies a very long time horizon between household decisions about 30 years moreover their model abstracts from many of the features of the u s tax code that we include here in addition to examining the consequences of flattening the marginal tax schedule we investigate the growth effects attributable to other parts of the flat tax proposal such as allowing full investment expensing eliminating the double taxation of business income and increasing the standard personal deduction

stochastic dominance tests abstract we develop stochastic dominance tests of a given prospect compared with multiple choice alternatives we account for all types of preferences the tests are formulated in terms of linear as well as mip models and developed based on bayesian analysis which relies on novel markov chain monte carlo procedures empirical results indicate that the market portfolio is prospect stochastic dominance optimal this implies that there are s shaped utility functions that rationalize the market portfolio