mimicking portfolios and exact arbitrage pricing we characterize the sets of mimicking positions with returns that can serve in place of factors in an exact k factor arbitrage pricing relation for a set of n assets all of the sets are k dimensional nonsingular linear transformations of each other we interpret three examples of such transformations and discuss empirical considerations we provide conditions under which the mimicking positions can be expressed as portfolios and we characterize the relation between mimicking portfolios and the minimumvariance frontier

national institutions and subnational development in africa we investigate the role of national institutions on subnational african development in a novel framework that accounts both for local geography and cultural genetic traits we exploit the fact that the political boundaries in the eve of african independence partitioned more than two hundred ethnic groups across adjacent countries subjecting similar cultures residing in homogeneous geographic areas to different formal institutions using both a matching type and a spatial regression discontinuity approach we show that differences in countrywide institutional structures across the national border do not explain within ethnicity differences in economic performance as captured by satellite images of light density the average non effect of national institutions on ethnic development masks considerable heterogeneity partially driven by the diminishing role of national institutions in areas further from the capital cities

mutual fund performance an analysis of quarterly portfolio holdings this article employs the 1975 84 quarterly holdings of a sample of mutual funds to construct an estimate of their gross returns this sample which is not subject to survivorship bias is used in conjunction with a sample that contains the actual net returns of the mutual funds in addition to allowing the authors to estimate the bias in measured performance that is due to the survival requirement and to estimate total transaction costs the sample is used to test for the existence of abnormal performance the tests indicate that the risk adjusted gross returns of some funds were significantly positive copyright 1989 by the university of chicago

a general mean variance approximation to expected utility for short holding periods the mean variance model is precisely consistent with the expected utility hypothesis only in the special cases of normally distributed security returns or quadratic utility functions there is little evidence however that security returns follow normal distributions see 13 for references and quadratic preferences can be shown to generate implausible results exhibiting increasing absolute risk aversion in the pratt ll arrow 1 2 sense and displaying negative marginal utility after some finite wealth level in addition hakansson 4 has shown that single period mean variance efficient portfolios can have disastrous consequences over time even when return distributions are stationary such criticisms of the mean variance approach within the von neumann morgenstern framework have prompted several writers to suggest that investors maximize the expected value of utility functions with more realistic properties while others have criticized the single period focus of the model one popular alternative utility function is the logarithmic function which exhibits decreasing absolute risk aversion and conveniently leads to myopic decision processes through time i e investors treat each period as if it were the last basing investment decisions on that period s wealth and return distributions only 8 4 other utility functions with constant relative risk aversion such as the power function also imply myopic decision rules within a multiperiod setting

how aid targets votes the impact of electoral incentives on foreign aid distribution despite allegations that foreign aid promotes corruption and patronage little is known about how recipient governments electoral incentives influence aid spending this article proposes a distributional politics model of aid spending in which governments use their informational advantages over donors in order to allocate a disproportionate share of aid to electorally strategic supporters allowing governments to translate aid into votes to evaluate this argument the author codes data on the spatial distribution of multilateral donor projects in kenya from 1992 to 2010 and shows that kenyan governments have consistently influenced the aid allocation process in favor of copartisan and coethnic voters a bias that holds for each of kenya s last three regimes he confirms that aid distribution increases incumbent vote share this evidence suggests that electoral motivations play a significant role in aid allocation and that distributional politics may help explain the gap between donor intentions and outcomes

the effect of contemporaneous reserve accounting on the market for federal funds abstract this paper evaluates the effect of the transition from lagged to contemporaneous reserve accounting for the determination of bank reserve requirements through its impact on the market for federal funds the results indicate that increased target reserve uncertainty resulting from the implementation of the contemporaneous reserve accounting system cra caused an initial increase in intraday federal funds rate variance and daily interest rate differences however subsequent to a learning period intraday variance appears to be less pronounced and daily differentials appear to be narrower than under the previously used lagged reserve accounting system lra these results are attributed to the lengthening of the accounting period from one to two weeks therefore while not costless the new system does not appear to have seriously disrupted the federal funds market

approximate factor structures interpretations and implications for empirical tests this paper provides some new insights about approximate factor structures as defined by chamberlain and rothschild 2 and their implications for empirical tests first we show that any economy that satisfies an approximate factor structure can be transformed in a manner that does not alter the characteristics of investor portfolios into an economy that satisfies an exact factor structure as defined by ross 9 second we show that principal components analysis represents just one of many methods of forming groups of well diversified portfolios with no idiosyncratic risk in large samples correct factor loadings will be obtained by regressing security returns on any group of these portfolios our interpretations of the chamberlain and rothschild results also provide additional insights into the testability of the arbitrage pricing theory we show that securities cannot be repackaged to hide factors in the manner suggested by shanken 10 without the variance of some of the repackaged securities approaching infinity in large economies

multiple equilibrium overnight rates in a dynamic interbank market game abstract we analyse a two period model of the interbank market i e the market where banks trade liquidity we assume that banks do not take the interbank interest rate as given but instead negotiate on interest rates and transaction volumes with each other the solution concept applied is the shapley value we show that there are a multiplicity of average equilibrium interest rates of the first period so that the average interest rate in this period does not convey any information on the expected liquidity situation on the interbank market as the banks control not only the transaction volumes but also the interest rates they can leave the interest rates constant and adjust the transaction volumes when for example a liquidity deficit becomes more likely

the mean variance efficiency of benchmark portfolios uk evidence abstract this paper examines the ex ante mean variance efficiency of four alternative benchmark portfolios within a uk context each of the benchmark portfolios is shown to be mean variance inefficient over the period january 1980 to december 1989 additionally the gibbons et al test statistic of efficiency appears to be fairly robust to violations in the distributional assumptions gibbons m r s a ross and j shanken 1989 test of the efficiency of a given portfolio econometrica 57 1121 1152

arbitrage pricing with estimation risk this paper considers the arbitrage pricing theory when investors have incomplete infor mation on the parameters generating asset returns each asset in the economy may have a different amount of information available on it bayesian investors use their prior beliefs in conjunction with the total available information to assign an expected return and a set of factor betas to each asset the assigned expected returns are shown to be linear in their associated factor betas however the factor betas and prices of assets differ from those under complete information specifically risky assets with high low information are priced relatively higher lower on the other hand factor betas of high low information assets are relatively lower higher the analysis has econometric implications for testing the apt in this paper s framework maximum likelihood estimates of factor betas which are based on normality assumptions are too high low for high low information assets in addition sequentially increasing the sample size by adding new securities to a factor analysis procedure can result in the detection of apparent additional priced factors when they do not really exist

the microstructure of the euro money market abstract this paper provides an empirical examination of the microstructure of the euro money market especially the overnight market the interbank market for short term funds in the transnational currency created in january 1999 the institutional framework shaping the microstructure of the money market can be delimited as the union of 1 central banks interest setting bodies and their long term policy strategy 2 instruments for monetary policy operations and liquidity management 3 the private market financial instruments and trading mechanisms for funds and 4 the payment and settlement infrastructure for the transfer of those funds all four elements can significantly influence the intraday behaviour of money market rates to study their effects on the euro money market 5 months of intraday data for overnight deposits have been recorded from brokers in four euro area countries and the uk posting their quotes on reuters and from the italian electronic market mid the results show two hump shaped or u shaped intraday patterns of quoting frequency and volatility but flatter intraday patterns sometimes weakly single hump shaped for bid ask spreads even intraday overnight rate levels hardly differ across brokers located in different euro area countries reflecting the high integration of this market already shortly after the introduction of the euro despite some remaining heterogeneities in market structures and trading channels quoting activity rate volatility and spreads increase on ecb governing council days particularly after the 1 45 pm release time of interest rate decisions however since the amplitude of this volatility is economically small and since turnovers are not indicative of adverse selection the average degree of policy uncertainty seems to have been rather limited during our sample period ecb announcements of new m3 data related to the first pillar of its monetary policy strategy around 10am seem to be associated with very moderate increases in short term volatility tuesdays eurosystem main refinancing auctions with the open market exhibit active pre and post auction liquidity re allocation but only a very short and moderate increase in volatility after the announcement of the allotments and no signs of market power or adverse selection open market operation settlement days exhibit the highest turnovers during the business week at least for the mid without however being affected by any special risks finally it is shown that spreads and volatility tend to be very high at the end of the minimum reserve maintenance period and that the same happened during the year 2000 changeover days reflecting the high risks involved in both

the federal reserve s new operating procedures a post mortem abstract although money stock targeting has been the strategic focus of federal reserve policy since the mid 1970 s operating policy the tactics whereby the longer run strategy is implemented over short term intervals has been changed by the federal reserve at least twice over this period a particularly dramatic change in operating policy was announced by the federal reserve in october 1979 this paper provides empirical evidence that settles questions about the nature of this change and suggests that the new operating procedures may have contributed to the heightened interest rate volatility experienced over the 1979 to 1982 period

the interbank market after august 2007 what has changed and why after the onset of the financial crisis spreads between interbank interest rates on unsecured and secured deposits for the major world currencies became exceptionally large and volatile first we find that the phenomenon was mainly driven by aggregate rather than bank specific factors notably risk aversion and accounting practices by contrast funding liquidity capital shortage and central bank interventions were not important determinants second prior to august 2007 the spread was broadly insensitive to key borrower characteristics whereas afterward it became somewhat more reactive to measures of creditworthiness third conditions for big borrowers became relatively more favorable during the crisis suggesting that moral hazard risks related to the too big to fail argument have increased these results are discussed in the light of theories on the interbank market during a crisis

small states small problems income growth and volatility in small states abstract small states have attracted a large amount of research in this paper we test whether small states are any different from other states in terms of their income growth and volatility outcomes we find that controlling for location small states have higher per capita gdp than other states this income advantage is largely due to a productivity advantage constituting evidence against the idea that small states suffer from an inability to exploit increasing returns to scale small states also do not have different per capita growth rates than other states small states do have greater volatility of annual growth rates which is in part due to their greater volatility of terms of trade shocks this terms of trade based volatility is in turn due to small states greater openness their greater openness on balance has however a positive net payoff for growth the one differential policy measure that might be relevant for small states is to further open up to international capital markets in order to better diversify risk but the benefits of even that are still unresolved in the literature we conclude that small states are no different from large states and so should receive the same policy advice that large states do

the fed and short term rates is it open market operations open mouth operations or interest rate smoothing abstract it is widely believed that the fed controls the federal funds rate by altering the degree of pressure in the reserve market through open market operations when it changes its target for the funds rate recently however several analysts have suggested that the fed need not conduct open market operations to change the funds rate rather they argue it is sufficient that the fed indicate its desire for the funds rate this paper notes that there is yet a third alternative the interest rate smoothing hypothesis that suggests that the fed does not move rates per se but rather smooths the transition of rates to the new equilibrium required by economic shocks this paper tests the open market and open mouth alternatives using a methodology first used by cook and hahn journal of monetary economics 1989a 331 finding no evidence that either open market operations or open mouth operations can account for the close relationship between the funds rate and the funds rate target a variety of evidence consistent with the interest rate smoothing hypothesis is considered the results suggest that many changes in the fed s funds rate target are an endogenous response to economic events and suggest that an alternative way to identify exogenous changes in policy is to identify exogenous changes in the fed s funds rate target

where are the gains from international diversification eafe and international marketlike mandates are popular with u s institutional fund sponsors the rationale seems to be that the international equity market has higher expected returns than the u s equity market and can substantially diversify u s portfolios the empirical evidence for the 1970 94 period does not support either claim nor does theory help asset pricing models do not argue that risk factors have geographically different expected returns recent research for the u s market shows that two risk factors value and size explain differences in expected returns across equity portfolios preliminary evidence suggests that the same factors work in foreign markets as well international value stocks and international small stocks diversify u s portfolios more than eafe in fact a sensible reason to diversify internationally is to load up on value stocks and small stocks without concentrating in one geographic region if one does not wish to concentrate in such stocks then international di

some results in the theory of arbitrage pricing this paper derives a stronger version of huberman s recent preference free pricing theorem this pricing result relates the expected return on an asset to its factor responses and the covariance structure of the residuals from a linear factor model it must characterize any infinite asset economy in which no arbitrage opportunities are present whether or not the factor model has uncorrelated residuals this result provides the intuition for the role of residual risk in the pricing model and eliminates some classes of arbitrage opportunities still present under huberman s bound some applications to empirical tests and performance measurement are also discussed the arbitrage pricing theory is one of several financial pricing models which attempts to explain the cross sectional variation in expected returns on assets in certain respects it is similar to the capital asset pricing model but there are both substantive and subtle differences one of the key advantages of the apt is that it derives a simple linear pricing relation approximating that in the capm without some of the latter s objectionable assumptions perhaps the key disadvantage of the apt is that it provides no clues as to what might be important factors nor as to how to interpret the factor premiums which appear in the pricing equation this paper serves several purposes after reviewing the linear factor model formulation in section i it derives in section ii a stronger version of huberman s 9 recent preference free pricing theorem this pricing result relates the expected return on an asset to its factor responses and the covariance structure of the residuals this relation must characterize any infinite asset economy in which no arbitrage opportunities are present whether or not a linear factor model with uncorrelated residuals is the appropriate returns generating mechanism section iii specializes this result by eliminating the effects of residual covariances and compares the results here to those of previous apt models when applied to the standard linear factor model with uncorrelated residuals this new pricing bound eliminates arbitrage opportunities which remain under huberman s bound this result also provides for the first time the intuition for the role of residual risk in the approximate pricing relation section v provides an interpretation of the factor premiums and gives a valid asset pricing model interpretation to the apt which is consistent with merton s

exact arbitrage pricing and the minimum variance frontier the author examines the relationship between the arbitrage pricing theory of ross and mean variance analysis in particular conditions are derived on the vector of the factor risk premia that are equivalent to the existence of a strictly positively weighted portfolio on the minimum variance frontier also a sufficient condition is given under which the existence of a positive minimum variance portfolio of all the assets in the economy will imply the existence of a positive minimum variance portfolio on a subset this means that rejection of the hypothesis of the existence of a positive minimum variance portfolio on a subset satisfying this condition implies rejection for the whole set a growing body of literature explores the relationship between the arbitrage pricing theory apt of ross 13 14 and the mean variance model among the early work in this direction were the papers of chamberlain and rothschild 2 and chamberlain 1 these papers examine a sequence of economies and characterize the relationship in the limit between the mean and portfolio cost functionals and the minimum variance frontier chamberlain 1 also gives a condition under which exact arbitrage pricing will hold dybvig 4 and grinblatt and titman 7 examine equilibrium models in an apt context for a finite economy they derive sharp bounds on the deviation from exact arbitrage pricing recent papers by huberman kandel and stambaugh 9 and grinblatt and titman 8 explore the relationship between the apt and the mean variance model by studying portfolios that can be used as proxies for the factors and examining the relationship these portfolios bear to the minimum variance frontier these two papers also deal with equilibrium models in spite of the number and variety of equilibrium apt models the question of the pricing of factor risk in equilibrium remains largely unexplored this paper makes some progress in addressing that issue by looking at a given equilibrium restriction and studying the constraints it imposes on the vector of factor premia itself the most familiar equilibrium restriction we might study is the central implication of the capital asset pricing model capm that the market portfolio is efficient in particular no portfolio with the same expected return as the market portfolio has a smaller variance the restriction we actually study is weaker than

on the sensitivity of mean variance efficient portfolios to changes in asset means some analytical and computational results tbis paper investigates the sensitivity of meanvariance mv efficientportfolios to changes in the means of individual assets when only a budget constraint is imposed on the investment problem the analytical results indicate that an mv efficient portfolio s weights mean and variance can be extremely sensitive to cbanges in asset means when nonnegativity constraints are also imposed on the problem the computational results confirm that a positively weigbted mv efficient portfolio s weigbts are extremely sensitive to cbanges in asset means but the portfolio s returns are not a surprisingly small increase in the mean of just one asset drives balf the securities from the portfolio yet the portfolio s expected return and standard deviation are virtually uncbanged this paper supersedes should investors hold well diversified portfolios financial support from the natural science and engineering research council of canada is gratefully acknowledged we also acknowledge the most capable assistance of ruth cornale simon ng jean marc potier and frederick shen the paper was presented at simon fraser university and the western finance association meetings in san diego we thank the participants especially stephen brown john herzog john heaney ray koopman and bruce lehmann and the editors jon ingersoll and chester spatt for

an intraday examination of the federal funds market implications for the theories of the reverse j pattern the intraday literature suggests that returns variances and volume form an intraday reverse j pattern two competing theories explain the observed patterns private information about future security prices and trading stoppages the federal funds market allows a unique opportunity to study the causes of intraday patterns because private information common to most markets does not play a role in setting prices we find reverse j variance patterns while accounting for generalized autoregressive conditional heteroskedasticity garch model effects our results support trading stops as an explanation for the reverse j pattern and suggest that private information is not a necessary condition for the observed pattern

the relation between mean variance efficiency and arbitrage pricing the mean standard deviation diagram has proven to be a valuable tool for understanding equilibrium asset pricing theory first introduced by markowitz 1952 1959 and tobin 1958 the diagram helps students and researchers alike to develop intuition about the capital asset pricing model capm its properties are useful for analyzing the conditions under which the market portfolio is mean variance efficient and for linking the location of the market portfolio in the diagram with the validity of the capm in addition its simple geometry seems to be the critical inspiration for roll s 1977 argument that the capm cannot feasibly be tested because the market portfolio is unobservable and because of a mathematical equivalence between the individual return beta linearity relation and the market portfolio s mean variance efficiency p 129 recent research on equilibrium asset pricing both theoretical and empirical has tended to focus on multibeta pricing models especially the arbitrage pricing theory apt this paper will show that the simple intuition derived from the

an instantaneous control model of bank reserves and federal funds management abstract empirical evidence indicates that large banks are generally net buyers of federal funds while small banks tend to be net sellers asymmetric information bank monopoly power or risk aversion arguments have been offered for this phenomenon however these models do not address the close link between bank reserves and federal funds purchases as alternative means of liquidity management our stochastic control model focuses on this link and has three main implications 1 it analyzes interaction between the above mentioned influences 2 it identifies three additional reasons for banks federal funds activity and 3 it examines the transmission of monetary policy in a dynamic framework

a note on the geometry of shanken s csr t2 test for mean variance efficiency abstract shanken 1985 derives a test for the zero beta capital asset pricing model capm which as he points out is equivalent to a test of the mean variance efficiency of the market portfolio this note illustrates the geometry of shanken s test in the mean variance space

a micro model of the federal funds market this paper demonstrates that valuable insights into the determination of federal funds rates can be gained through modeling the micro decisions of market participants fed fund demand functions are derived for different bank valuation functions and several implications are discussed specifically it is i possible to rationalize the observation that large banks are net purchasers and small banks net sellers of fed funds ii to explain the positive spread of fed funds rates over other short term money market rates and iii to link the size of this spread to the federal reserve s underlying monetary policy strategy

an examination of resampled portfolio efficiency we examined the out of sample performance of using resampled portfolio efficiency an approach proposed in 1998 in international asset allocation strategies for the period january 1983 to may 2000 for most models we used to estimate expected returns using strategies based on resampled portfolio efficiency provided some benefits in terms of improved sharpe ratios and abnormal returns over using traditional mean variance strategies we found little evidence however that active mean variance strategies or resampled efficiency strategies would have generated significantly positive abnormal returns for the time period we considered

the daily market for funds in europe what has changed with the emu this paper shows that the existence of deposit and lending facilities combined with an averaging provision for the reserve requirement are powerful tools to stabilize the overnight rate we reach this conclusion by comparing the behavior of this rate in germany before and after the start of the emu the analysis of the german experience allows us to isolate the effects on the overnight rate of these particular instruments of monetary policy to illustrate that this outcome is a general conclusion and not a particular result of the german market we develop a theoretical model of reserve management which is able to reproduce our empirical findings

an asset pricing theory unifying the capm and apt this study shows that the competitive equilibrium version of the arbitrage pricing theory may be extended to develop an exact mode l if idiosyncratic risks obey the ross separating distribution the r esults indicate that one only need add the market portfolio as an ext ra factor to the factor model in order to obtain an exact asset prici ng relation the empirical arbitrage pricing theory is also general ized to allow for some factors to be omitted from the econometric m odel employed to test the theory the importance of the market portfo lio is shown to be a monotonic increasing function of the number of o mitted factors copyright 1988 by american finance association

money creation and the shadow banking system many explanations for the rapid growth of the shadow banking system in the mid2000s focus on money demand this paper asks whether the short term liabilities of the shadow banking system behave like money we rst present a simple model where households demand money services which are supplied by three types of claims deposits treasury bills and asset backed commercial paper abcp the model provides predictions for the price and quantity dynamics of these claims as well as the behavior of the banking system in terms of issuance and the monetary authority in terms of open market operations consistent with the model the empirical evidence suggests that the shadow banking system does respond to money demand

hedging with futures does anything beat the naive hedging strategy this paper investigates out of sample performance of the naive hedging strategy relative to that of the minimum variance hedging strategy in which the covariance parameters are estimated from 18 e

cross country differences in monetary policy execution and money market rates volatility abstract volatility patterns in overnight interest rates display differences across industrial countries that existing models designed to replicate the features of individual countries markets cannot account for this paper presents an equilibrium model of the overnight interbank market that matches cross country differences in patterns in interest volatility by incorporating differences in how central banks manage liquidity in response to shocks our model is consistent with central banks practice of rationing access to marginal facilities when the objective of stabilizing short term interest rates conflicts with another high frequency objective such as an exchange rate target

a new approach to testing asset pricing models the bilinear paradigm we propose a new approach to estimating and testing asset pricing models in the context of a bilinear paradigm introduced by kruskal 18 this approach is both simple and at the same time quite general as an illustration we apply it to the special case of the arbitrage pricing model where the number of factors is pre specified the data appear to be generally in conflict with a five or seven factor representation of the model used by roll and ross 30 when we consider the number of replications of our test and the large number of observations on which it is performed the frequency with which we reject the three factor apm does not lead us to conclude that this model is unrepresentative of security returns further the rejection of the five and seven factor versions is to be expected if the three factor version is correct the paradigm gives insight into the appropriate specification of the model and suggests that there may be a small number of economy wide factors that affect security returns tests of asset pricing models on the basis of observed stock market data have represented a staple of the financial economics literature of the past twenty years the early work is reviewed in the famous paper by jensen 12 and papers by fama and macbeth 6 rosenberg and marathe 31 and roll and ross 30 there has been a great deal of confusion regarding what testable propositions are implied by these models see discussion in roll 29 in this paper we show that at a minimum all asset pricing models yet proposed imply a simple easily testable hypothesis which we refer to as the bilinear hypothesis while specific models may imply further testable propositions if the bilinear hypothesis is rejected the model is inconsistent with the data and should be rejected our test exploits the fact that the economic content of any equilibrium asset pricing model can be expressed in the form of a potentially refutable constraint on the set of parameters of the process generating security returns this constraint specifies that given a set of security specific characteristics there exists a linear relationship common across securities relating expected returns to these

a critical reexamination of the empirical evidence on the arbitrage pricing theory this paper demonstrates that the roll and ross rr and other previously published tests of the apt are subject to several basic limitations there is a general nonequivalence of factor analyzing small groups of securities and factor analyzing a group of securities sufficiently large for the apt model to hold it is found that as one increases the number of securities the number of factors determined increases this increase in the number of factors with larger groups of securities cannot readily be explained by a distinction between priced and nonpriced risk factors as it is impermissible to carry out tests on whether a given risk factor is priced using factor analytic procedures the apt model as exposited by ross 17 18 and extended by huberman 9 has provided the basis of an extensive literature as for example brown and weinstein 1 chen 3 hughes 10 ingersoll 11 jobson 12 reinganum 15 roll and ross rr 16 and shanken 17 to mention but a few it has also been treated in a more general context by chamberlain and rothschild 2 our purpose here is not to comment on this collection of papers many of which are unpublished but to reexamine the evidence presented by rr and point out major pitfalls involved in the empirical methodology employed by them and others who have followed their lead rr claim that on theoretical and more importantly on empirical grounds arbitrage pricing theory apt is an attractive alternative to the capital asset pricing model capm the apt it is argued requires less stringent and presumably more plausible assumptions is more readily testable since it does not require the measurement of the market portfolio and may be better able to explain the anomalies found in the application of the capm to asset returns the acceptability of the apt like that of the capm or any other theory ultimately depends on its ability to explain the relevant empirical evidence our subsequent discussion will show that many of the prqblems associated with the capm are also present in the apt context and that its ability to explain the relevant empirical evidence is not markedly superior moreover it raises questions not only about the rr and related empirical investigations of the apt but also about the testability of that theory in the present state of the art a major part of the problem results from the necessity to break down the universe being analyzed through the apt model this is forced upon the investigator by the fact

good day sunshine stock returns and the weather psychological evidence and casual intuition predict that sunny weather is associated with upbeat mood this paper examines the relationship between morning sunshine in the city of a country s leading stock exchange and daily market index returns across 26 countries from 1982 to 1997 sunshine is strongly significantly correlated with stock returns after controlling for sunshine rain and snow are unrelated to returns substantial use of weather based strategies was optimal for a trader with very low transactions costs however because these strategies involve frequent trades fairly modest costs eliminate the gains these findings are difficult to reconcile with fully rational price setting

portfolio performance evaluation old issues and new insights this article presents a model that provides insights about various measures of portfolio performance the model explores several criticisms of these measures these include the problem of identifying an appropriate benchmark portfolio the possibility of overestimating risk because of market timing ability and the failure of informed investors to earn positive risk adjusted returns because of increasing risk aversion the article argues that these need not be serious impediments to performance evaluation

fixed costs and the behavior of the federal funds rate abstract this paper presents an equilibrium model of the federal funds market that ties movements in the funds rate to changes in the supply of reserves and to a fixed cost facing banks that borrow at the discount window it is found that the existence of the fixed cost is capable of explaining a number of features of the funds market in particular it is critical for explaining occasional instances of extremely high funds rates it also provides an explanation for heterogeneous behavior across banks towards the discount window and for higher average funds rates at the end of maintenance periods

the empirical foundations of the arbitrage pricing theory abstract this paper uses maximum likelihood factor analysis of large cross sections to examine the validity of the arbitrage pricing theory apt we are unable to explain the expected returns on firm size portfolios although we do explain the expected returns on portfolios formed on the basis of dividend yield and own variance where risk adjustment using the usual capm market proxies fails we also compare alternate versions of the apt and sharply reject the hypothesis that basis portfolios formed to mimic the factors span the mean variance frontier of the individual assets

the federal funds market and the overnight eurodollar market abstract this paper investigates the effect of daily management of federal reserve accounts by us depository institutions on the interest rate outside the us spindt and hoffmeister journal of financial and quantitative analysis 23 1988 401 griffiths and winters journal of banking and finance 19 1995 1265 and hamilton journal of political economy 104 1996 22 found that the fed funds rate exhibited calendar day effects caused by federal reserve regulations i find that the overnight eurodollar rate shows similar predictable daily changes as does the fed funds rate although the absolute magnitudes are slightly less the empirical results support the hypothesis that the tendencies in daily changes in the two overnight interest rates are caused by the characteristics of the fed funds market

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

does aid affect inequality we show that there was a negative correlation between pro poor aid and inequality in the period before the mid 2000s this article provides an explanation for this observed relationship using pane

a variance equality test of the icapm on philippine stocks post asian financial crisis period the study examines whether fama s discrete version of merton s intertemporal capm icapm can explain the negative market risk premium and the cross sectional variability of philippine stock returns after the onset of the asian financial crisis in july 1997 the change in foreign exchange rate in addition to the change in market risk premium is used as a state variable of hedging concern to investors the relationship of fama s multifactor minimum variance mmv portfolio to the markowitz minimum variance mv portfolio is characterized in terms of the equality of the return variances for the same expected return a test due to basak et al 2002 is then used to verify the equality of the return variance of a derived tangency portfolio along the mmv frontier to an mv portfolio with the same sample mean return the results do not reject the icapm during the period covered by the study thus the model provides a plausible explanation both for the cross sectional variability of stock returns and the nega

confidence in the familiar an international perspective one striking feature of intemrnational portfolio investment is the extent to which equity portfolios are concentrated in the domestic equity market of the investor the home bias puzzle i examine the role of investors perception of foreign investment risk on their portfolio choices the expected retumrns and risk of foreign investment are specified through an asset pricing model with the home portfolio being the benchmark asset pastor s 2000 domestic capm the model serves as a reference point around which investors can center their prior beliefs i focus on investors prior beliefs that are consistent with the literature on confidence in the familiar foreign equities in terms of both expected returns and risk being viewed less favorably than domestic equities these prior beliefs are then combined with the data on g7 equities and the revised beliefs are used to obtain the global optimal asset allocation to hold predominantly domestic equities each g7 investor has to believe that the risk of foreign investment is several times higher than the actual risk the home bias is more of a puzzle for a u s investor during the 1970s specifying investors prior beliefs around the world capm does not help resolve the puzzle

the analytics of performance measurement using a security market line security market line sml analysis while an important tool has never been fully justified from a theoretical standpoint assuming symmetric information and an inefficient index we show that sml analysis can be grossly misleading since in general efficient and inefficient portfolios can plot above and below the sml on a more positive note if sml analysis uses the return on a marketed riskless asset for the zero beta rate efficient portfolios must plot above the sml nonetheless arbitrarily inefficient portfolios also plot above the sml mean variance theory is still the premier theory in finance it continues to survive theoretical criticism and empirical rejection2 and it does so in no small part because of the popularity of using deviations from the security market line sml in performance measurement of portfolio managers and in event studies of the price impact of information the sml is the relationship between risk and return predicted by the mean variance model namely that risk as measured by beta and expected return are linearly related sml analysis interprets deviations in expected return from the sml as abnormal returns above or below what is appropriate or warranted for the amount of risk taken on however in the mean variance model all assets and portfolios lie on the sml ex ante and any ex post deviations from the sml are attributable solely to statistical measurement errors it is for this reason that roll 22 25 has argued that justification for sml analysis must lie outside the original mean variance model the purpose of this paper and its companion paper dybvig and ross 8 is to study whether sml analysis is valid in several plausible theoretical frameworks i e whether theory justifies intuition specifically in this article we examine the validity of using sml analysis when the index portfolio is inefficient in the companion paper we look at performance yale school of management the authors appreciate especially helpful comments from michael brennan gregory conner mike gibbons mark grinblatt jon ingersoll paul pfeiderer and richard roll the first author is grateful for support under the batterymarch fellowship program and the second author is grateful for support from the national science foundation this paper and its campanion paper dybvig and ross 8 evolved from dybvig and ross 7

day of the week effects in federal funds rates further empirical findings abstract we extend the spindt and hoffmeister 1988 model of the daily operation of an institution s federal reserve account to show strong inter and intra period incentives to borrow and lend in the federal funds market at predictable points in the 10 trading day settlement period using intraday high and low prices we demonstrate changes in the federal funds rate consistent with our model s predictions we provide evidence of predictable changes in the variance of fed funds returns on a daily and intraday basis our analysis confirms that federal reserve requirements result in daily and intraday variances which are not constant

the micromechanics of the federal funds market implications for day of the week effects in funds rate variability the federal funds rate arguably is the most important interest rate in the u s capital market because it plays a central role in monetary policy and the term structure this paper examines the micromechanics of the funds market we show that in a continuous market with asynchronous trading regulatory constraints and accounting conventions that focus agents attention on discrete time instants have important implications for the dynamics of trading activity and realized market prices we also exhibit a model of the market that explains observed regularities in the intertemporal behavior of the funds rate

the aid effectiveness literature the sad results of 40 years of research abstract the aid effectiveness literature ael consists of empirical macroeconomic estimates of the effects of development aid by the end of 2004 it comprised 97 econometric studies of three families of related effects each family has been analyzed in a separate meta analysis the ael is an ideal subject for meta analysis as it uses only a few formally similar models to estimate the same underlying effects it is also an area with strong beliefs often generated by altruism when this whole literature is examined a clear pattern emerges after 40 years of development aid the preponderance of the evidence indicates that aid has not been effective we show that the distribution of results is significantly asymmetric reflecting the reluctance of the research community to publish negative results the dutch disease effect on exchange rates provides a plausible explanation for the observed aid ineffectiveness

interest rate corridors and reserves abstract this paper evaluates reserves regimes versus interest rate corridors which have become competing frameworks for monetary policy implementation rate corridors relying on lending and deposit facilities to create ceilings and floors for overnight interest rates evince mixed results on controlling volatility reserve requirements allow period average smoothing of interest rates but even if remunerated are subject to reserve avoidance activities a system of voluntary period average reserve commitments could offer equivalent rate smoothing advantages if central banks created symmetric opportunity costs of meeting or falling short of period average reserve requirements or commitments they could achieve flat reserve demand on settlement day

some empirical tests of the theory of arbitrage pricing we estimate the parameters of ross s arbitrage pricing theory apt using daily return data during the 1963 78 period we compare the evidence on the apt and the capital asset pricing model capm as implemented by market indices and find that the apt performs well the theory is further supported in that estimated expected returns depend on estimated factor loadings and variables such as own variance and firm size do not contribute additional explanatory power to that of the factor loadings

is foreign aid fungible evidence from the education and health sectors this paper adopts a new approach to the issue of foreign aid fungibility in contrast to most existing empirical studies panel data are employed that contain information on the specific purposes for which aid is given this allows linking aid that is provided for education and health purposes to recipient public spending in these sectors in addition aid flows that are recorded on a recipient s budget are distinguished from those that are not recorded on budget and the previous failure to differentiate between on and off budget aid is shown to produce biased estimates of fungibility sector program aid is the measure of on budget aid whereas technical cooperation serves as a proxy for off budget aid the appropriate treatment of off budget aid leads to lower fungibility estimates than those reported in many previous studies specifically in both sectors and across a range of specifications technical cooperation which is the largest component of total education and health aid leads to at most a small displacement of recipient public expenditures

a computational model of banks optimal reserve management policy abstract this paper uses numerical methods to model the demand for excess reserves by a representative bank in a framework that includes many realistic features of the current reserve market structure in the united states in particular the model incorporates a 14 day maintenance period and an accurate representation of carryover provisions we use the model to evaluate the effect of various changes to the operating environment increased uncertainty modified penalties and changes to policy paying interest on reserves

bank behavior interest rate determination and monetary policy in a financial system with an intraday federal funds market abstract this paper has two purposes one is to construct a formal model of the determination of and relationships between interest rates on funds with 24 hour overnight and intraday terms the second is to use this model to examine the likely effects of alternative federal reserve proposals for addressing the issue of intraday extension of federal reserve credit in the form of daylight overdrafts of bank reserve accounts it is demonstrated that present proposals all entail potentially significant drawbacks for monetary policy

the sampling error in estimates of mean variance efficient portfolio weights this paper presents an exact finite sample statistical procedure for testing hypotheses about the weights of mean variance efficient portfolios the estimation and inference procedures on efficient portfolio weights are performed in the same way as for the coefficients in an ols regression ols t and f statistics can be used for tests on efficient weights and when returns are multivariate normal these statistics have exact t and f distributions in a finite sample using 20 years of data on 11 country stock indexes we find that the sampling error in estimates of the weights of a global efficient portfolio is large

aid and growth at the regional level this paper brings the aid effectiveness debate to the sub national level we hypothesize the non robust results regarding the effects of aid on development in the previous literature to arise due to the effects of aid being insufficiently large to measurably affect aggregate outcomes using geo coded data for world bank aid to a maximum of 2 221 first level administrative regions adm1 and 54 167 second level administrative regions adm2 in 130 countries over the 2000 2011 period we test whether aid affects development measured as nighttime light growth our preferred identification strategy exploits variation arising from interacting a variable that indicates whether or not a country has passed the threshold for receiving ida s concessional aid with a recipient region s probability to receive aid in a sample of 478 adm1 regions and almost 8 400 adm2 regions from 21 countries controlling for the levels of the interacted variables the interaction provides a powerful and excludable instrument overall we find significant correlations between aid and growth in adm2 regions but no causal effects acknowledgements this paper is part of a research project on macroeconomic policy in low income countries supported by the u k department for international development dfid the views expressed in this paper are those of the authors and do not necessarily represent those of the imf imf policy or dfid we thank andrea presbitero seminar participants at the development research group meeting at the university of goettingen the conference on financing for development geneva 2015 and the centre for the studies of african economies conference oxford 2015 for helpful comments and jamie parsons for proofreading

a unified beta pricing theory abstract this paper derives ross s mutual fund separation theory and a new equilibrium version of ross s arbitrage pricing theory as special cases of a general theory the paper also reveals that the two theories are identical in their predictions of asset prices and portfolio returns the capital asset pricing model a restricted case of the mutual fund separation theory receives special treatment

day to day monetary policy and the volatility of the federal funds rate we propose a model of the interbank money market with an explicit role for central bank intervention and periodic reserve requirements and study the interaction of profit maximizing banks with a central bank targeting interest rates at high frequency the model yields predictions on biweekly patterns of the federal funds rate s volatility and on its response to changes in target rates and in intervention procedures such as those implemented by the fed in 1994 theoretical results are consistent with empirical patterns of interest rate volatility in the u s market for federal funds

on the simultaneity problem in the aid and growth debate this paper shows that foreign aid has a significant positive average effect on real per capita gross domestic product gdp growth if and only if the quantitatively large negative reverse causal effect of per capita gdp growth on foreign aid is adjusted for in the growth regression instrumental variables estimates show that a 1 percentage point increase in gdp per capita growth decreased foreign aid by over 4 adjusting for this quantitatively large negative reverse causal effect of economic growth on foreign aid shows that a 1 increase in foreign aid increased real per capita gdp growth by around 0 1 percentage points

simple optimal policy for cash management the average balance requirement case this paper treats a problem of stochastic cash management under an average compensating balance requirement it develops a dynamic programming formulation of the problem in which the relevant state is a unidimensional quantity equivalent to the forecasted average balance at the end of the averaging period under usably broad conditions it establishes the optimality of a transient policy of simple type similar to the two sided inventory type policy familiar from certain earlier studies of stationary cash balance problems having absolute balance requirements the results apply to cases in which the transactions costs contain both fixed and proportional components the paper discusses also a numerical example drawn from the literature of the cash balance problem and shows by simulation of the optimal and simply modified forms of the optimal policy that good protection is afforded against negative balances even though the model does not explicitly constrain the negative balance probabilities

banks as monitors of other banks evidence from the overnight federal funds market this study provides evidence that banks are effective monitors of their peers by showing that the interest rate paid on federal funds transactions reflects differences in credit risk across borrowers in addition the size and relative importance in the funds market of the trading institutions are shown to affect the rates charged for overnight borrowing thereby providing insight into the nature of competition in the federal funds market transaction volume and size of transaction effects are uncovered as is evidence of relationship banking between banks these results are made possible by unique data identifying individual federal funds transactions copyright 2001 by university of chicago press

posterior predictive and utility based approaches to testing the arbitrage pricing theory abstract to provide a framework for judging the economic significance of departures from the arbitrage pricing theory we adopt a utility based metric based on optimal portfolio choices this measure is examined using both predictive and posterior analysis our predictive analysis shows very large and economically significant departures from the model restrictions however the high level of parameter uncertainty suggests that we cannot conclusively either affirm or reject the apt our conclusions differ markedly from other studies which employ traditional significance testing procedures and in many instances fail to reject the apt restrictions

does aid for trade diversify the export structure of recipient countries the importance of aid for trade as a tool for facilitating trade economic growth and social development has received attention since the concept was introduced in 2005 while one of the main targets of aid for trade is export diversification reflecting the fact that the exports of many developing countries are concentrated in a small range of items there have not been many efforts to measure the effect of aid for trade on export structure this study therefore attempts to trace the relationship between aid for trade and 133 aid recipients export structure between 1996 and 2013 using the herfindahl hirschman index to measure the degree of export concentration the findings suggest that total aid for trade has reduced the concentration level in the short run in the long run on the other hand aid for trade has had no significant effect on export structure of recipient countries only aid for building productive capacity which is one of the three categories of aid for trade contributes to lower concentration yet this change is not caused by an increase in export diversity but by the redistribution of shares of existing products of a similar sophistication level

on correlations and inferences about mean variance efficiency a framework is presented for investigating the mean variance efficiency of an unobservable portfolio based on its correlation with a proxy portfolio a sensitivity analysis derives the highest correlation between the proxy and a portfolio that reverses the inference of a test of sharpe lintner tangency for example the maximum correlation between the value weighted nyse amex portfolio and a portfolio inferred tangent ranges from 0 76 to 0 48 we also test whether the correlation between the proxy and the tangent portfolio exceeds a given level this hypothesis is often rejected for the nyse amex proxy at a correlation of 0 7

international portfolio diversification with estimation risk international portfolio diversification has long been advocated as a way of enhancing average returns while reducing portfolio risk for the investor who considers diversifying into foreign securities this proposition however relies on the assumption that the required inputs to the classical mean variance analysis are known with certainty typically expected returns variances and covariances are simply replaced by their ex post sample values and the optimal portfolio is derived without mentioning the uncertainty inherent in these parameter values but the rational investor should take this uncertainty into account when forming expectations and probably will consider estimators that are less subject to estimation error than the classical sample mean this paper investigates alternative estimators of expected returns and their implications for the alleged gains from diversification an important observation is the crucial influence that errors in estimating expected returns have on portfolio analysis a closer examiprevious studies of international portfolio diversification have relied on ex post meanvariance analysis without considering the problem of estimation risk typically past averages are substituted for expected returns and no allowance is made for the uncertainty inherent in these parameter values first i demonstrate the shortcomings of such an approach and second i investigate another method of estimating expected returns initially proposed by stein by shrinking the sample averages toward a common mean i find that the out of sample performance of the optimal portfolio is substantially increased one of the implications of this method is that the classical conclusions vastly overestimate the possible gains in average returns instead benefits from diversification are more likely to accrue from a reduction in risk this paper draws on part of my dissertation at the university of chicago i am grateful to arnold zellner michael mussa george constantinides and especially john bilson for useful discussions and comments numerous improvements were also suggested by the referee this research received the generous financial support of the college interuniversitaire d etudes doctorales dans les sciences du management

the road less travelled institutional aspects of data and their influence on empirical estimates with an application to tests of forward rate unbiasedness the difference between data used in empirical studies and that envisioned in the theory can influence empirical estimates sometimes by enough that the direction of future research is altered this paper illustrates how in the context of tests of forward rate unbiasedness a lack of articulation about the mechanics underlying foreign exchange market speculation and about the institutional aspects governing spot and forward rate contracts leads to sampling of the data in a way that is not consistent with the theory the authors find that the sampling problems account for some but not all of the bias in the coefficient on the forward premium copyright 1996 by royal economic society

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

yes the apt is testable the arbitrage pricing theory apt has been proposed as an alternative to the meanvariance capital asset pricing model capm this paper considers the testability of the apt and points out the irrelevance for testing of the approximation error we refute shanken s objections including his assertion that roll s critique of the capm is applicable to the apt we also explain the testability of the apt on subsets and we explore the relationship between the apt and the capm the arbitrage pricing theory apt has been the subject of extensive research efforts since it was introduced by ross 36 37 the research has included theoretical papers and a growing empirical literature 2 nonetheless there seems to be some confusion in the literature about the relation between the theoretical underpinnings of the apt and its empirical tests this paper is an attempt to alleviate the confusion to illustrate the issues and to provide a focus section i of this paper is devoted to examining and refuting some points raised in shanken 40 which considers the testability of the apt the underlying premise of the apt is that asset returns ri are generated by a factor model of the form

us food aid and civil conflict we study the effect of us food aid on conflict in recipient countries our analysis exploits time variation in food aid shipments due to changes in us wheat production and cross sectional variation in a country s tendency to receive any us food aid according to our estimates an increase in us food aid increases the incidence and duration of civil conflicts but has no robust effect on interstate conflicts or the onset of civil conflicts we also provide suggestive evidence that the effects are most pronounced in countries with a recent history of civil conflict jel d74 f35 o17 o19 q11 q18 we are unable to determine whether our aid helps or hinders one or more parties to the conflict it is clear that the losses particularly looted assets constitutes a serious barrier to the efficient and effective provision of assistance and can contribute to the war economy this raises a serious challenge for the humanitarian community can humanitarians be accused of fueling or prolonging the conflict in these two countries medecins sans frontieres amsterdam 1

performance measurement with selectivity market and volatility timing the performance of portfolio managers depends on market timing volatility timing and security selection we develop holdings based performance measures that adjust for risk using stochastic discount factors display all three components in a consistent framework and avoid strong assumptions about managers behavior previous models leave out some of the components of performance and correcting for this we deliver better measures of selectivity sorting stocks held by funds on selectivity produces a quintile spread in four factor alphas greater than 2 5 per year before costs and more than 1 7 greater than found using the daniel grinblatt titman and wermers 1997 measure

aid and growth what does the cross country evidence really show abstract we examine the effects of aid on growth in cross sectional and panel data after correcting for the possible bias that poorer or stronger growth may draw aid contributions to recipient co

global estimates of market and non market values derived from nighttime satellite imagery land cover and ecosystem service valuation we estimated global marketed and non marketed economic value from two classified satellite images with global coverage at 1 km2 resolution gdp a measure of marketed economic output is correlated with the amount of light energy le emitted by that nation as measured by nighttime satellite images le emitted is more spatially explicit than whole country gdp may for some nations or regions be a more accurate indicator of economic activity than gdp itself can be directly observed and can be easily updated on an annual basis as far as we know this is the first global map of estimated economic activity produced at this high spatial resolution 1 km2 ecosystem services product esp is an important type of non marketed value esp at 1 km2 resolution was estimated using the igbp land cover dataset and unit ecosystem service values estimated by costanza et al valuing ecosystem services with efficiency fairness and sustainability as goals nature s services island press washington dc pp 49 70 the sum of these two gdp esp sep is a measure of the subtotal ecological economic product marketed plus a significant portion of the non marketed the ratio esp sep 100 esp is a measure of proportion of the sep from ecosystem services both sep and esp were calculated and mapped for each 1 km2 pixel on the earth s surface and aggregated by country results show the detailed spatial patterns of gdp esp and sep also available at http www du edu psutton esiindexisee ecoleconesi htm globally while gdp is concentrated in the northern industrialized countries esp is concentrated in tropical regions and in wetlands and other coastal systems esp ranges from 1 for belgium and luxembourg to 3 for the netherlands 18 for india 22 for the united states 49 for costa rica 57 for chile 73 for brazil and 92 for russia while gdp per capita has the usual northern industrialized countries at the top of the list sep per capita shows a quite different picture with a mixture of countries with either high gdp capita high esp capita or a combination near the top of the list finally we compare our results with two other indices 1 the 2001 environmental sustainability index esi derived as an initiative of the global leaders of tomorrow environment task force world economic forum and 2 ecological footprints of nations how much nature do they use how much nature do they have developed by mathis wackernagel and others while both of these indices purport to measure sustainability the esi is actually mainly a measure of economic activity and is correlated with gdp while the eco footprint index is a measure of environmental impact the related eco deficit national ecological capacity minus national footprint correlates well with esp

the demand for excess reserves this paper provides an estimate of the demand for excess reserves in the united states it finds that excess reserves are negatively related to the federal funds rate and positively related to transactions deposits it also finds that clearing needs significantly affect the demand for reserves with increases in excess reserves coming in response to lower required reserve balances and higher clearing volume some implications for monetary policy are discussed the demand for excess reserves is at the center of a number of issues in monetary economics while at one time it was featured primarily in the calculation of money multipliers more recently it has figured in federal reserve policy through its connection to the targeting of the federal funds rate each week the open market desk is obligated to forecast the demand for reserves including the demand for excess reserves to determine the amount of reserves to supply through open market operations this shift in the role of excess reserves is reflected worldwide a number of countries have abandoned reserve requirements altogether and the entire connection between monetary policy and the economy is through the demand for excess reserves this paper looks at recent data on excess reserves in the united states to determine the sensitivity of demand to changes in interest rates and other variables affecting the willingness to hold reserves the standard approach to modeling the demand for excess reserves is to treat it as part of a bank s liquidity management decision banks want to hold reserves to avoid overdraft or reserve deficiency penalties on their account at the central bank when facing uncertain flows of funds this general model of the precautionary demand for reserves was given by poole 1968 two basic propositions fall out of this approach the first is that the quantity of excess reserves demanded should vary inversely with short term interest rates which are the opportunity cost of holding reserves assuming that excess reserves pay no interest the second proposition is that since excess reserves are providing a buffer against uncertainty about reserve balances demand should increase with uncertainty the textbook model of excess reserve demand assumes that this uncertainty increases proportionately with the level of transactions deposits this paper finds support for both of these propositions in recent years excess reserves have increased with the growth in transactions deposits and were negatively related to interest rates decreasing roughly 120 million for each percentage point increase in the federal funds rate the role of excess reserves in monetary policy depends on the particular operational strategy adopted by the central bank the approach in the united states shifted in 1982 when the