money capital and real liquidity effects with habit formation the money in utility model is reconsidered in the presence of endogenous labour and habits with standard assumptions about preferences and a policy rule that sets the nominal interest rate by adjusting the growth rate of money the model exhibits superneutrality in the steady state nevertheless habits give rise to real liquidity effects in the short run after an increase in the nominal interest rate employment falls resulting in a fall in capital accumulation and in the short and long term real interest rates the adjustment of the capital stock is non monotonic employment and the short and long term real interest rates may also adjust non monotonically jel classification e22 e52 e58 monnaie capital et effets reels de liquidite quand il y a formation d habitudes on re examine le role de la monnaie dans un modele d utilite quand travail et formation d habitudes sont endogenes dans le cadre des postulats usuels a propos des preferences et d une regle de politique qui definit le taux d interet en ajustant le rythme de croissance de la monnaie le modele fait preuve de super neutralite en regime permanent neanmoins les habitudes entrainent des effets reels de liquiditea court terme apres un accroissement dans le taux d interet nominal l emploi chute ce qui entraine un ralentissement dans l accumulation du capital et une chute des taux d interet reels a court et a long terme l ajustement dans le stock de capital n est pas monotone l emploi et les taux d interet reels a court et a long terme peuvent aussi ne pas s ajuster de facon monotone

testing the unbiasedness hypothesis in the forward foreign exchange market a specification analysis abstract this paper evaluates two popular regression methods of testing the unbiasedness hypothesis in the forward foreign exchange market for the 30 day canada united states forward foreign exchange market the evidence overwhelmingly indicates that it is inappropriate to treat the structure of the systematic and stochastic components of the test relations as constant over time hence conclusions inferred from parameter significance testing based upon full sample estimation can be very misleading accordingly we argue for a specification analysis of the test relations and more explicit modelling of market fundamentals

measuring noise in exchange rate models abstract this paper conducts a race between models in terms of their ability to explain observed violations of uncovered interest parity this is done by comparing the empirical performance of the simple efficiency hypothesis and the models which assume the existence of risk premiums my analysis uses noise ratios which complement specification tests by showing the relative degree to which each model reconciles with the data the empirical results imply that the risk premiums introduced by the latent variable model could significantly explain the deviation of forward exhange rates from the expected future spot rates

turnover in the afdc population an event history analysis the control group of families with female heads from the denver income maintenance experiment is utilized in this analysis of afdc turnover this study uses event history techniques a methodology that is more appropriate for exploring welfare dynamics than the logit approach of earlier work increases in age and the wage have significant negative effects on the rate of entering afdc a higher guarantee raises this rate significantly age and the guarantee have significant effects with opposite signs on the exit rate other variables are not systematically related to turnover the estimates are applied to projected changes in lengths of time spent on and off afdc and in afdc caseloads due to changes in the explanatory variables

uninsurable risk and financial market puzzles abstract we compare the empirical performances of three risk sharing arrangements involving idiosyncratic skill shocks a where individuals are unable to directly insure their consumption against individual specific shocks b where agents strike long term insurance contract with financial intermediaries involving a truth revelation constraint as in kocherlakota and pistaferri 2009 c full risk sharing based on the widely accepted assumption of cross sectional log normality of individual consumption levels we work out closed form expressions of the pricing kernels for a and b we put these three models to test four financial market anomalies namely the equity premium currency premium risk free rate and consumption real exchange rate puzzles simultaneously in an integrated framework we find that the pricing kernel associated with a outperforms the other two models in terms of the produced estimates of the agent s preference parameters and the model ability to predict the equity and currency premia the risk free rate and the log growth in the exchange rate however the predictive ability is still far from satisfactory for all three models under scrutiny

solving exchange rate puzzles with neither sticky prices nor trade costs we present a simple framework in which both the exchange rates disconnect and forward bias puzzles are simultaneously resolved the flexible price two country monetary model is extended to include a consumption externality with habit persistence habit persistence is modeled using campbell cochrane preferences with deep habits along the lines of the work of ravn schmitt grohe and uribe by deep habits we mean habits defined over goods rather than countries the model is simulated using the artificial economy methodology it offers a neo classical explanation of the meese rogoff puzzle and mimics the failure of fundamentals to explain nominal exchange rates in a linear setting finally the model naturally generates the negative slope in the standard forward market regression

spot and forward volatility in foreign exchange this paper investigates the empirical relation between spot and forward implied volatility in foreign exchange we formulate and test the forward volatility unbiasedness hypothesis which is the volatility analogue to the extensively researched hypothesis of unbiasedness in forward exchange rates using a new data set of spot implied volatility quoted on over the counter currency options we compute the forward implied volatility that corresponds to the forward contract on future spot implied volatility known as a forward volatility agreement we nd statistically signi cant evidence that forward implied volatility is a systematically biased predictor that overestimates future spot implied volatility the bias in forward volatility generates high economic value to an investor exploiting predictability in the returns to volatility speculation and indicates the presence of predictable volatility term premiums in foreign exchange

welfare dependence and recidivism in an era of welfare reform this study examines the dynamics of welfare programme participation during the initial period 1993 1995 of programme reforms at the state level in iowa the programme changes for the state were remarkably similar to the national reforms implemented in the usa in 1996 analysis of the family investment program fip participation over the programme s first two years show that on average recipients stayed fewer months in the second year compared with the first although a relatively large share of participants 36 stayed on for the full two years fixed effect and semiparametric duration models are used to examine welfare dependence and recidivism respectively results indicate that income from wages and child support are significant factors in reducing welfare participation child support and wage income are crucial in determining the chances of exiting and of staying off the programme especially during the early months of the exit

incentive effects of the u s welfare system a review the author would like to acknowledge support for prior work on this topic from the u s department of health and human services and helpful comments from three anonymous referees rebecca blank howard chernick john fitzgerald irwin garfinkel peter gottschalk edward gramlich david greenberg judith gueron james heckman v joseph hotz robert hutchens michael keane frank levy larry mead michael murray robert plotnick anuradha rangarajan philip robins howard rolston jeffrey smith and daniel weinberg all opinions and errors are those of the author alone

the speculative efficiency hypothesis the hypothesis that forward prices are the best unbiased forecast of future spot prices is often presented in the economic and financial analysis of futures markets this paper considers the hypothesis independently of its implications for rational expectations or market efficiency and in order to stress this fact the term speculative efficiency is used to characterize the state envisaged under the hypothesis if a market is subject to efficient speculation the supply of speculative funds is infinitely elastic at the forward price that is equal to the expected future spot price the expected future spot price is a market price determined as the solution to the underlying rational expectations macroeconomic model although the paper is primarily concerned with testing this hypothesis in the foreign exchange market the methodology introduced in the paper is of general application to all futures markets this abstract was borrowed from another version of this item

interest rates and currency prices in a two country world abstract this paper is a theoretical study of the determination of prices interest rates and currency exchange rates set in an infinitely lived two country world which is subject both to stochastic endowment shocks and to monetary instability formulas are obtained for pricing all equity claims nominally denominated bonds and currencies and these formulas are related to earlier closely related results in the theories of money finance international trade

exchange rate puzzles and distorted beliefs abstract we propose a new explanation for the foreign exchange forward premium and delayed overshooting puzzles we show that both puzzles arise from a systematic distortion in investors beliefs about the interest rate process accordingly the forward premium is always a biased predictor of future depreciation the bias can be so severe as to lead to negative coefficients in the fama regression delayed overshooting may or may not occur depending upon the persistence of interest rate innovations and the degree of misperception we document empirically the extent of this distortion using survey data for g 7 countries against the u s and find that it is strong enough to account for these irregularities

incomplete markets borrowing constraints and the foreign exchange risk premium abstract this paper solves a model consisting of two monetary economies with incomplete markets in which agents are subject to borrowing constraints the paper investigates if such a framework is able to account for the volatility and the size of the foreign exchange risk premium the model succeeds in increasing substantially the volatility of the risk premium to about 30 of that in the data however this more volatile risk premium does not translate into sufficiently large predictable excess returns it thus appears unlikely that excess returns from currency speculation can be uniquely explained by a time varying risk premium in an incomplete markets economy with exogenous borrowing constraints

an exploration of the forward premium puzzle in currency markets a standard empirical finding is that expected changes in exchange rates and interest rate differentials across countries are negatively related implying that uncovered interest rate parity is violated in the data this article provides new empirical evidence that suggests that violations of uncovered interest rate parity and its economic implications depend on the sign of the interest rate differentially a framework related to term structure models is developed to account for the puzzling relationship between expected changes in exchange rates and interest rate differentials estimation results suggest that a particular term structure model can account for the puzzling empirical evidence article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

the pricing of forward contracts for foreign exchange this paper investigates the nature of observed deviations from the unbiased expectations hypothesis in the forward foreign exchange market if these deviations are due to risk premia then the same premia should be observed in nominal bonds denominated in different currencies this condition imposes testable restrictions on the parameters of a multivariate regression model the empirical results are consistent with a world in which time varying risk premia cause the observed deviations from unbiased expectations

forward and spot exchange rates in a multi currency world separate literatures study violations of uncovered interest parity uip using regression based and portfolio based methods we propose a decomposition of these violations into a cross currency a between time and currency and a cross time component that allows us to analytically relate regression based and portfolio based facts and to estimate the joint restrictions they put on models of currency returns subject to standard assumptions on investors information sets we find that the forward premium puzzle fpp and the dollar trade anomaly are intimately linked both are driven almost exclusively by the cross time component by contrast the carry trade anomaly is driven largely by cross sectional violations of uip the simplest model that the data do not reject features a cross sectional asymmetry that makes some currencies pay permanently higher expected returns than others and larger time series variation in expected returns on the u s dollar than on other currencies importantly conventional estimates of the fpp are not directly informative about expected returns because they do not correct for uncertainty about future mean interest rates once we correct for this uncertainty we never reject the null that investors expect high interest rate currencies to depreciate not appreciate

rational speculation and exchange rates abstract models of exchange rates have typically failed to produce results consistent with the key fact that real and nominal exchange rates move in ways not closely connected to current or past macroeconomic variables models that rely on the same shocks to drive fluctuations in macroeconomic variables and exchange rates typically imply counterfactually strong co movements between them we develop a model in which new information leads agents to change their rational beliefs about risk premia on foreign exchange markets these changes in risk premia work through asset markets to cause real and nominal exchange rates to change without corresponding changes in gdp productivity money supplies and other key macro variables

less of a puzzle a new look at the forward forex market abstract the two country monetary model is extended to include a consumption externality with habit persistence the model is simulated using the artificial economy methodology the puzzles in the forward market are re examined the model is able to account for a the low volatility of the forward discount b the higher volatility of expected forward speculative profit c the even higher volatility of the spot return d the persistence in the forward discount e the martingale behavior of spot exchange rates and f the negative covariance between the expected spot return and expected forward speculative profit it is unable to account for the forward market bias because the volatility of the expected spot return is too large relative to the volatility of the expected forward speculative profit

habits and durability in consumption and the dynamics of the current account abstract a model in which consumption exhibits durability and habits develop over the flow of services provided by them is used to study current account dynamics durability leads to adjacent substitutability in consumption while habits are assumed to lead to adjacent complementarity the adjustment of the current account may be non monotonic if habit effects are dominant in the short run and durability effects in the long run then after a terms of trade deterioration we will have a current account deficit followed by a surplus the j curve in the opposite case a surplus will be followed by a deficit 1998 elsevier science b v

on the foreign exchange risk premium in a general equilibrium model abstract the foreign exchange risk premium in a cash in advance model is investigated some weaknesses of the definition of the risk premium generally used are discussed it is shown that the primary ultimate source of foreign exchange risk is the covariance of monetary shocks with real output shocks several studies have assumed this covariance is zero and hence assumed away the major source of risk in the model finally the risk premium generated from standard versions of this model is argued to be very small because it is the same order of magnitudeas covariances of money and output growth rates

profits risk and uncertainty in foreign exchange markets this paper examines the properties of nominal profits from speculation in dollar dominated forward contracts using a representative agent cash in advance model modified to allow for heteroscedasticity in the exogenous processes the model is simulated by estimating exogenous processes from the data and the remaining free parameters with a simulated method of moments technique simulated expected profits are variable heteroskedastic and serially correlated but the magnitude of these second moments fall short of those of the predictable component of observed profits on the u s dollar as in the actual data simulated forward rates display biasedness in predicting simulated future spot rates

the carry trade and fundamentals nothing to fear but feer itself the carry trade is the investment strategy of going long in high yield target currencies and short in low yield funding currencies recently this nave trade has seen very high returns for long periods followed by large crash losses after large depreciations of the target currencies based on low sharpe ratios and negative skew these trades could appear unattractive even when diversied across many currencies but more sophisticated conditional trading strategies exhibit more favorable payos we apply novel within economics binary outcome classication tests to show that our directional trading forecasts are informa tive and out of sample loss function analysis to examine trading performance the critical conditioning variable we argue is the fundamental equilibrium exchange rate feer expected returns are lower all else equal when the target currency is overvalued like traders researchers should incorporate this information when evaluating trading strategies when we do so some questions are resolved negative skewness is purged and market volatility vix is uncorrelated with returns other puzzles remain the more sophisticated strategy has a very high sharpe ratio suggesting market ineciency

can cross country portfolio rebalancing give rise to forward bias in fx markets abstract this paper develops a model of exchange rate dynamics that takes into account positions in foreign and domestic equities in addition to standard short term riskless securities the modeling of cross country stock holdings is motivated by evidence that a large and ever increasing proportion of currency flows has been directed toward national stock markets to the extent that there is not perfect risk sharing investors tend to hold currency risk and international equity risk as a bundle this paper examines the impact of such cross country covariance risk on the relationship between exchange rate returns and interest rate differentials in particular we show that the sign and magnitude of the coefficient on the lagged interest differential is governed by a type of time varying beta risk that reflects the conditional covariance between exchange rate returns and the return differential between foreign and domestic equities as this cross country beta is predominantly negative our results have direct implications on the empirical failure of the uncovered interest parity uip hypothesis suggesting that the traditional uip regression equation is confounded in a non standard nonlinear way by the presence of cross country equity flows simulation experiments show that accounting for such portfolio rebalancing activities may in part help to explain the anomalous slope coefficient associated with the forward premium

an intertemporal general equilibrium model of asset prices this paper develops a continuous time general equilibrium model of a simple but complete economy and uses it to examine the behavior of asset prices in this model asset prices and their stochastic properties are determined endogenously one principal result is a partial differential equation which asset prices must satisfy the solution of this equation gives the equilibrium price of any asset in terms of the underlying real variables in the economy in this paper we develop a general equilibrium asset pricing model for use in applied research an important feature of the model is its integration of real and financial markets among other things the model endogenously determines the stochastic process followed by the equilibrium price of any financial asset and shows how this process depends on the underlying real variables the model is fully consistent with rational expectations and maximizing behavior on the part of all agents our framework is general enough to include many of the fundamental forces affecting asset markets yet it is tractable enough to be specialized easily to produce specific testable results furthermore the model can be extended in a number of straightforward ways consequently it is well suited to a wide variety of applications for example in a companion paper cox ingersoll and ross 7 we use the model to develop a theory of the term structure of interest rates many studies have been concerned with various aspects of asset pricing under uncertainty the most relevant to our work are the important papers on intertemporal asset pricing by merton 19 and lucas 16 working in a continuous time framework merton derives a relationship among the equilibrium expected rates of return on assets he shows that when investment opportunities are changing randomly over time this relationship will include effects which have no analogue in a static one period model lucas considers an economy with homogeneous individuals and a single consumption good which is produced by a number of processes the random output of these processes is exogenously determined and perishable assets are defined as claims to all or a part of the output of a process and the equilibrium determines the asset prices our theory draws on some elements of both of these papers like merton we formulate our model in continuous time and make full use of the analytical tractability that this affords the economic structure of our model is somewhat similar to that of lucas however we include both endogenous production and

the implications of first order risk aversion for asset market risk premiums abstract in an effort to explain simultaneously the excess return predictability observed in equity bond and foreign exchange markets we incorporate preferences exhibiting first order risk aversion into a general equilibrium two country monetary model when we calibrate the model to us and japanese data we find that first order risk aversion substantially increases excess return predictability however this increased predictability is insufficient to match the data we conclude that the observed patterns of excess return predictability are unlikely to be explained purely by time varying risk premiums generated by highly risk averse agents in a complete markets economy

time varying risk interest rates and exchange rates in general equilibrium under mild assumptions the data indicate that time varying risk is the primary force driving nominal interest rate differentials on currency denominated bonds this finding is an immediate implication of the fact that exchange rates are roughly random walks a general equilibrium monetary model with an endogenous source of risk variation a variable degree of asset market segmentation can produce key features of actual interest rates and exchange rates in this model the endogenous segmentation arises from a fixed cost for agents to exchange money for assets as inflation varies so does the benefit of asset market participation and that changes the fraction of agents participating these effects lead the risk premium to vary systematically with the level of inflation this model produces variation in the risk premium even though the fundamental shocks have constant conditional variances

sources of variation in international real interest rates this paper analyses the effects of inflation on ex post real interest rates in an international framework a dynamic factor model is estimated in which real interest rates are influenced by real interest and inflation factors that are common to all the countries and by country specific factors we find that the source of domestic inflation is an important determinant of the effect of inflation on real interest rates a common inflation factor has a negative effect on ex post real interest rates lending support to a form of the mundell tobin effect in international real interest rates and that a country specific inflation factor tends to have a positive effect

an equilibrium model of exchange rate determination and asset pricing with nontraded goods and imperfect information this paper presents a two country model with maximizing households stochastic production stochastic money growth and perfect capital mobility because of the presence of nontraded goods households in different countries consume different goods analytic solutions are presented for the nominal exchange rate the real exchange rate nominal interest rates and real interest rates it is shown that the model is compatible with some important features of the real world behavior of exchange rates when households are imperfectly informed about the distribution of money growth the exchange rate exhibits patterns of overshooting and is more volatile than the ratio of the money stocks copyright 1987 by university of chicago press

forward discount puzzle and liquidity effects some evidence from exchange rates among the united states canada and japan this paper empirically examines whether the interaction between foreign exchange markets and monetary markets can help to resolve the forward discount puzzle following the monetary models of lucas 1990 and fuerst 1992 we define as liquidity effects the negative impact of monetary injection on nominal interest rates temporary deviations from the standard euler equation the liquidity effect identified by these models weakens the linkage between current forward rates and expected future spot rates and improves on the standard rational expectations model that predicts a one to one correspondence between the two using time series of exchange rates among the united states canada and japan this paper shows that the liquidity measure identified above has an impact on forward premiums and that once the liquidity effect is taken into consideration the unbiased prediction of the forward discount rate is recovered to some extent in a theoretically consistent manner

trade in nominal assets and net international capital flows abstract nominal assets play a major role in international financial markets while trade in indexed bonds is limited as a result agents are exposed to both price and exchange rate uncertainty nonetheless previous research on net capital flows has assumed the presence of a risk free vehicle to intertemporal asset trade in this paper we develop a general equilibrium intertemporal model with trade limited to nominal bonds and equity we find that exposure to nominal risk dampens net capital flows thus making economies effectively more closed

macroeconomic sources of foreign exchange risk in new eu members abstract we address the issue of foreign exchange risk and its macroeconomic determinants in several new eu members we derive the observable macroeconomic factors consumption and inflation using the stochastic discount factor sdf approach the joint distribution of excess returns in the foreign exchange market and the factors are modeled using a multivariate garch in mean specification our findings show that both real and nominal factors play important roles in explaining the variability of the foreign exchange risk premium both types of factors should be included in monetary general equilibrium models employed to study excess returns to contribute to the further stability of domestic currencies the new eu members should strive to implement stabilization policies aimed at achieving nominal as well as real convergence with the core eu members

macroeconomic fundamentals and the exchange rate dynamics a no arbitrage macro finance approach abstract in this paper we propose an arbitrage free international macro finance model that links the exchange rate dynamics to macroeconomic fundamentals jointly using data on exchange rates yields of zero coupon bonds and macroeconomic variables of the us and the euro area we find a close link between macroeconomic fundamentals and the exchange rate dynamics the model implied monthly exchange rate changes can explain about 57 variation of the observed data the macroeconomic innovations can help capture large variation of exchange rate changes robustness checks show that the results also hold for other major exchange rates

on the microeconomics of food and malnutrition under endogenous discounting abstract this paper explores the microeconomics and dynamics of food and nutrition it examines the linkages between malnutrition and the incentive to invest and accumulate capital the analysis focuses on a dynamic model where preferences about the future depend on nutrition and health situations of malnutrition cover both ends of the spectrum from nutrient deficiency to obesity the model involves preferences that are not time additive and exhibit endogenous discounting this provides a framework to investigate the factors affecting consumption and investment behavior the adverse investment incentives of malnutrition are examined

analyzing the length of welfare spells abstract this paper studies the determinants of the length of individual spells of welfare focusing on how the length of a spell affects the probability of its termination the analysis utilizes six years of monthly data on time spent in the afdc program among female household heads a variety of duration dependence models are estimated monthly afdc participation does not show strong evidence of duration dependence two distinct groups appear to utilize welfare one with a very low and constant probability of leaving welfare and a second group which is more affected by time on the program

an examination of uncovered interest rate parity in segmented international commodity markets we examine the effect of segmented commodity markets on the relation between forward and future spot exchange rates in a dynamic economy we calculate the slope coefficient in our theoretical economy from regressing exchange rate changes on forward premia with reasonable parameter values the slope coefficient is less than unity however even for extreme parameters the slope is not less than zero as found in the data a negative slope coefficient in a nominal version of the model requires the covariance between monetary shocks and relative output shocks to be significantly negative in contrast to the covariance in the data one of the most studied relations in international finance is that between forward exchange rates and future spot rates empirical tests typically find that when one regresses changes in spot rates on forward premia the slope coefficient is less than one and often negative this result is called the forward bias anomaly and implies that the returns from investing in forward exchange contracts are predictable our objective is to examine the effect of segmentation of international commodity markets on the relation between the forward premium and the change in the spot rate segmentation of commodity markets is modeled by introducing a cost for transferring goods across countries giving rise to deviations from purchasing power parity ppp in this article we first derive the theoretical implications of the effect of segmentation on the forward bias in a dynamic general equilibrium model and then analyze a calibrated version of the model our analysis serves as a useful benchmark to study how much of the predictable deviations from uncovered interest parity uip can be explained by endogenous deviations from ppp

changing beliefs and systematic rational forecast errors with evidence from foreign exchange this paper addresses a new interpretation to the appearance in the early 1980s of systematic errors in forecasting the dollar exchange rate following a change in the process of a fundamental variable market participants revise their beliefs about the process using bayes rule since the market does not immediately recognize the change forecast errors are on average wrong during a period when the market is rationally learning for conservative parameter values the learning behavior of the dollar exchange rate in the early 1980s appears consistent with about half of the dollar s underprediction implied by the forward market copyright 1989 by american economic association

the transition to a new inflation rate in models with habit formation abstract the money in utility model is re considered to allow for habit forming preferences in which habits develop over instantaneous utility from consumption and real money holdings an increase in the inflation rate does not affect the steady state level of capital or consumption but reduces the steady state levels of real money holdings and habits the model has important off steady state dynamics

accounting for forward rates in markets for foreign currency absteract forward and spot exchange rates between major currencies imply large standard deviations of both predictable returns from currency speculation and of the equilibrium price measure the intertemporal marginal rate of substitution representative agent theory with time additive preferences cannot account for either of these properties we show that the theory does considerably better along these dimensions when the representative agent s preferences exhibit habit persistence but that the theory fails to reproduce some of the other properties of the data in particular the strong autocorrelation of forward premiums since the advent of flexible exchange rates in the early 1970s a large body of statistical work has established that forward rates for major currencies are not optimal predictors of future spot rates relevant evidence is reported in studies by baillie lippens and mcmahon 1983 bekaert 1991 bilson 1981 boothe and longworth 1984 cumby 1988 cumby and obstfeld 1984 fama 1984 gregory and mccurdy 1984 hansen and hodrick 1983 hodrick and srivastava 1984 and korajczyk and viallet 1990 a more complete list of references is provided by hodrick 1987 these papers indicate that returns from speculation in forward and spot currency markets are predictable and that the predictable components vary considerably over time a number of alternative explanations have been offered for the predictable variation in foreign currency market excess returns kaminsky 1988 korajczyk 1985 and krasker 1980 suggest that infrequent extreme events may make returns appear predictable in small samples the so called peso problem lewis 1989 argues that rational learning following infrequent changes in the process governing equilibrium prices can explain part of the ex post predictability of currency returns froot and frankel 1989 and froot and thaler 1990 examine the hypothesis that market forecasts of future spot

anomalies foreign exchange most all behavior can be explained by assuming that agents have stable well defined preferences and make rational choices consistent with those preferences in markets that eventually clear an empirical result qualifies as an anomaly if it is difficult to rationalize or if implausible assumptions are necessary to explain it within the paradigm this column will present a series of such anomalies readers are invited to suggest topics for future columns by sending a note with some reference to or better yet copies of the relevant research comments on anomalies printed here are also welcome the address

exchange rates and long term bonds tentative evidence suggests that the empirical failure of uncovered interest parity uip is con fi ned to short term interest rates tests of uip for long term interest rates are however h

asset pricing puzzles and incomplete markets the representative agent theory of asset pricing is modified to incorporate heterogeneous agents and incomplete markets the model features two types of agents who differ up to a nontradable idiosyncratic component in their endowment processes numerical solutions indicate that individuals are able to diversify a substantial portion of their idiosyncratic income risk through riskless borrowing and lending alone restrictions on the variability of intertemporal marginal rates of substitution hansen and jagannathan 1991 are used to argue that incomplete markets as modeled here cannot account for the properties of asset returns that are anomalous from the perspective of representative agent theory a large literature in financial economics has investigated the extent to which variants of the lucas 1978 general equilibrium theory of asset pricing can account for the joint behavior of aggregate u s consumption and asset returns by and large this literature has concluded that a theory based upon frictionless arrow debreu markets and or a representative agent makes strongly counterfactual predictions regarding even the simple unconditional properties of this relationship mehra and prescott 1985 for instance show that the theory drastically underpredicts the average excess rate of return on u s stocks the so called equity premium puzzle weil 1989 points out as did mehra and prescott that the magnitude of the average risk free rate is far below that predicted by the theory this has been dubbed the risk free rate puzzle numerous authors including grossman melino and shiller 1987 and backus gregory and zin 1989 show that the theory cannot account for term premia inherent in the yield curve hodrick 1987 surveys a large literature which documents the theory s shortcomings in accounting for excess expected returns in foreign exchange markets the notion that the representative agent model cannot account for excess returns across a wide array of asset markets can be made more precise by using tools developed by hansen and jagannathan 1991 and shiller 1982

interest rate risk and the forward premium anomaly in foreign exchange markets this paper shows that even adjusted for the time varying risk premiums implied by the yield curves across countries uncovered interest parity is still strongly rejected by the data moreover factors that predict the excess bond returns are found not significant at all in predicting the foreign exchange returns these results reject the joint restrictions on the exchange rate and interest rates imposed by dynamic term structure models suggesting that foreign exchange markets and bond markets may not be fully integrated and we have to look beyond interest rate risk in order to understand the exchange rate anomaly

portfolio substitution and exchange rate volatility legal and institutional changes are making it easier to adjust foreign exchange portfolios this has raised fears that exchange rates will become increasingly volatile this paper presents an optimizing equilibrium model where varying degrees of portfolio substitutability are possible our results suggest that if preferences are nearly log linear or transactions costs are small exchange rate volatility rises as portfolios become more substitutable with empirically reasonable parameter values however volatility is little affected by substitutability an implication is that a transactions tax on foreign exchange trading would have little impact

on biases in the measurement of foreign exchange risk premiums abstract the hypothesis that the forward rate is an unbiased predictor of the future spot rate has been consistently rejected in recent empirical studies this paper examines several sources of measurement error and misspecification that might induce biases in such studies although previous inferences are shown to be robust to a failure to construct true returns and to omitted variable bias arising from conditional heteroskedasticity in spot rates we show that the parameters were not stable over the 1975 89 sample period estimation that allows for endogenous regime shifts in the parameters demonstrates that deviations from unbiasedness were more severe in the 1980s jel f31

heterogeneous expectations and tests of efficiency in the yen dollar forward exchange rate market this paper examines the efficiency of the forward yen dollar market using micro survey data conventional tests of unbiasedness do not correspond directly to the zero profit condition instead we use the survey data to calculate potential profits of individual forecasters based on a natural trading rule we find that although the survey data are not the best predictor of future spot rates in terms of typical mean square forecast error criteria the survey data can be used to obtain on average positive profits however these profits are small and highly variable similar results are found when we examine profits generated by a trading rule using regression forecasts the profits are found to be correlated with risk type variables but not other available information

the time variation of risk and return in foreign exchange markets a general equilibrium perspective this article successively introduces variable velocity durability and habit persistence in a standard two country general equilibrium model and explores their effects on the variability of exchange rate changes forward premiums and the foreign exchange risk premium a new feature of the model is that agents make decisions at a weekly frequency and face conditionally heteroskedastic shocks nevertheless even the most complex model fails to deliver sufficiently variable risk premiums without causing forward premiums and exchange rates to be excessively variable unlike previous models the model can roughly match the persistence of forward premiums article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

is it risk explaining deviations from uncovered interest parity abstract this paper analyzes ex ante returns to forward speculation and asks if these returns can be explained by models of a foreign exchange risk premium after presenting evidence that both nominal and real expected speculative profits are nonzero the paper examines if real returns to forward speculation are consistent with consumption based models of risk premia estimates of the conditional covariance between real speculative returns and real consumption growth are presented and like ex ante returns to forward speculation they exhibit statistically significant fluctuations over time and often change sign

an economic evaluation of empirical exchange rate models this paper provides a comprehensive evaluation of the short horizon predictive ability of economic fundamentals and forward premiums on monthly exchange rate returns in a framework that allows for volatility timing we implement bayesian methods for estimation and ranking of a set of empirical exchange rate models and construct combined forecasts based on bayesian model averaging more importantly we assess the economic value of the in sample and out of sample forecasting power of the empirical models and find two key results 1 a risk averse investor will pay a high performance fee to switch from a dynamic portfolio strategy based on the random walk model to one that conditions on the forward premium with stochastic volatility innovations and 2 strategies based on combined forecasts yield large economic gains over the random walk benchmark these two results are robust to reasonably high transaction costs

international capital markets and foreign exchange risk author s brennan michael j xia yihong abstract the relation between the volatilities of pricing kernels associated with di erent currencies and the volatility of the exchange rate between the currencies is derived under the assumption of integrated capital markets and the volatilities of the pricing kernels are related to the foreign exchange risk premium time series of pricing kernel volatilities are estimated from panel data on bond yields for five major currencies using a parsimonious term structure model that allows for time varying pricing kernel volatilities the resulting estimates are used to test hypotheses about the relation between the volatilities of the pricing kernels in di erent currencies and the volatility of the exchange rate as predicted time variation in foreign exchange risk premia is found to be related to time variation in both the volatility of the pricing kernels and the volatility of exchange rates the estimated pricing kernel volatilities can account for the forward premium puzzle in an average sense across exchange rates

child support welfare dependency and women s labor supply this study evaluates the potential effectiveness of alternative child support policies in reducing welfare program participation employing longitudinal data from the panel study of income dynamics the analysis addresses the simultaneity of women s decisions regarding welfare participation labor force participation and annual hours of work following marital breakup the estimation framework accounts for the endogeneity of child support payments with female labor supply and for the selection bias due to differential rates of remarriage among divorced separated women results show that higher child support payments would i decrease welfare participation and ii increase average hours of work the empirical estimates are used to assess the potential effects of adopting alternative child support policies such as the wisconsin child support assurance system these results suggest that large potential welfare cost savings are attainable but significant reductions in welfare participation rates would only be achieved through substantial improvements in child support enforcement or through government assured child support payments

the duration of welfare spells probability distributions for the duration of welfare spells are estimated the principle guiding the work is that a recipient will not exit from welfare if the expected utility on welfare exceeds the expected utility of welfare the analysis indicates that while the majority of welfare spells are of short duration a nontrivial minority of spells are quite long those recipients with long spells are found to differ in predictable ways from those experiencing brief spells this suggests that strategies to move women off welfare are unnecessary in many cases and should be targeted on those most likely to be long term recipients copyright 1987 by mit press

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

the role of exchange rates in intertemporal risk return relations abstract this paper investigates the significance of an intertemporal relation between expected returns on countries stock market portfolios and their risk exposures to the world market portfolio we find that the intertemporal risk return relation differs significantly under different currency denominations the slope coefficient is the largest at around seven when the returns are denominated in japanese yen moderate at about five when the returns are denominated in the canadian or us dollars and the smallest at around three when the returns are denominated in pound or euro and its predecessors the ranking of the risk return coefficients across different currency denominations remains the same when we replace country equity indices with global industry portfolios in estimating the intertemporal relations when we change the return frequency from monthly to daily and when we consider different specifications for the conditional covariance process

when do women use aid to families with dependent children and food stamps the dynamics of eligibility versus participation this paper investigates dynamic patterns in the relationship between eligibility and participation in the aid to families with dependent children afdc and food stamp programs using monthly longitudinal data from the survey of income and program participation the results indicate that there are many relatively short eligibility spells that do not result in program participation and end with increases in income participation is most likely to occur among women with lower current and future earnings opportunities and is affected by locational and policy parameters those who elect to participate in these programs tend to start receiving benefits almost immediately upon becoming eligible a substantial number of women exit these programs before their eligibility ends among at least some of these women it is likely that unreported changes in income are occurring in 1989 if all eligible single parent families had participated in afdc and food stamps benefit payments in these programs would have been 13 5 billion higher

child support welfare dependency and poverty female headed families have among the highest poverty rates of any major demographic group in the united states the purpose of this paperis to investigate empirically the effectiveness of current child support enforcement policies and to determine their role in reducing poverty and welfare dependency a special supplement to the april 1982 current population survey provides the data for the analysis the results indicate that child support enforce ment may represent an effective means for re ducing welfare program costs but isunlikely to have a dramatic effect on either welfare de pendency or poverty copyright 1986 by american economic association

foreign exchange market efficiency tests implications of recent empirical findings abstract the recent empirical literature on the efficiency of the foreign exchange market has been characterized by strikingly contradictory conclusions drawn from similar empirical evidence these contradictions result because 1 different maintained hypotheses are held and 2 different criteria e g micro versus macroeconomic are used to judge the evidence in this survey we organize the empirical literature under several headings the presence of risk premiums empirical regularities in regression tests profitable trading rules and advanced econometric techniques in integrating this material we consider the implications of the current evidence for investors forecasters policy makers and theorists

risk premia carry trade dynamics and economic value of currency speculation in this paper we derive the dynamics and assess the economic value of currency speculation by formalizing the concept of a trader inaction range we show that exchange rate returns comprise a time varying risk premium and that uncovered interest parity uip holds in a speculative sense the often cited forward bias puzzle originates from the omission of the risk premium in standard uip tests consistent with its popularity among market professionals the carry trade strategy can be rationalized as it systematically collects risk premia and generates economic value when applied in multi currency portfolios

the impact of data errors on measurement of the foreign exchange risk premium abstract in most situations measurement error produces bias which it less likely that the null hypothesis will be rejected in the case of regression equations designed to estimate the premiums impounded in forward exchange rates the reverse is true because the forward rate appears on both sides of the equation measurement error makes it more likely that a risk premium will be found however the empirical results reported here indicate that there is still evidence of a risk premium even after taking account of measurement error

market microstructure effects of government intervention in the foreign exchange market as asymmetric information model of the bid ask spread is developed for a foreign exchange market subject to occasional government interventions traditional tests of the unbiasedness of the forward rate as a predictor of the future spot rate are shown to be inconsistent when the rates are measured as the average of their respective bid and ask quotes larger bid ask spreads on fridays are documented reliable evidence of asymmetric bid ask spreads for all days of the week albeit more pronounced on fridays are presented the null hypothesis that the forward rate is an unbiased predictor of the future spot rate continues to be rejected the regression slope coefficients increase toward unity however indicating a less variable risk premium

interpreting the forward premium anomaly one of the central issues in international finance concerns the forward premium anomaly changes in spot exchange rates are inversely related to the premium of forward rates over spot rates the authors construct a numerical example of a theoretical economy with this property and discuss its potential as an explanation of the anomaly