bond liquidity premia recent asset pricing models of limits to arbitrage emphasize the role of funding conditions faced by financial intermediaries in the us the repo market is the key funding market then the premium of on the run u s treasury bonds should share a common component with risk premia in other markets

a comparison of the information in the libor and cmt term structures of interest rates abstract we investigate the information contained in the london interbank offered rate libor and the u s constant maturity treasury cmt term structure of interest rates and report three novel findings first we document that the information contained in term structures are significantly different from one another second we provide evidence of a significant change in the nature of this difference as the financial crisis began third we find that the significant changes in the information content of cmt and libor are consistent with significant shocks to credit default swap rates and tenor swap rates

price setting during low and high inflation evidence from mexico this paper provides new insight into the relationship between inflation and the setting of individual prices by examining a large data set of mexican consumer prices covering episodes of both low and high inflation when the annual rate of inflation is low below 10 15 the frequency of price changes comoves weakly with inflation because movements in the frequency of price decreases and increases partly offset each other in contrast the average magnitude of price changes correlates strongly with inflation because it is sensitive to movements in the relative shares of price increases and decreases when inflation rises beyond 10 15 few price decreases are observed and both the frequency and average magnitude are important determinants of inflation i show that a menu cost model with idiosyncratic technology shocks predicts the average frequency and magnitude of price changes well over a range of inflation similar to that experienced by mexico

real rigidities and the non neutrality of money rigidities in real prices are not sufficient to create rigidities in nominal prices and real effects of nominal shocks and by themselves small frictions in nominal adjustment such as costs of changing prices create only small non neutralities but this paper shows that substantial nominal rigidity can arise from a combination of real rigidities and small nominal frictions the paper shows the connection between real and nominal rigidity given the presence of nominal frictions both in general and for two specific sources of real rigidity one arising from goods market imperfections and the other from labour market imperfections

interest rate swaps abstract using quotations from two interest rate swap dealers with different credit ratings aaa and a we examine the effect of dealers credit reputations on swap quotations and bid offer spreads the aaa offer rates are significantly higher than the a offer rates and the aaa bid rates are significantly lower than the a bid rates we also document the relation between swap rates and par bond yields estimated from london interbank offered rate libor and bid rate libid data we identify some of the problems in testing the implications of swap pricing theory

the term structure of interest rates in a partially observable economy this paper investigates the term structure of interest rates in a multiperiod production and exchange economy with incomplete information unable to observe their stochastic investment opportunities investors engage in dynamic bayesian inference this results in the endogenous identification of a more complex production function which generates a richer term structure resembling the one that actual market prices imply in addition this paper introduces a characteristic function of the term structure and demonstrates that in contrast with a fully observable economy the widely investigated expectations hypothesis holds true only if interest rates are nonstochastic this paper investigates the term structure of interest rates in a dynamic production and exchange economy with an unobservable productivity factor in order to estimate the unobservable stochastic investment opportunities rational investors engage in dynamic bayesian inference anticipated changes in investors quality of information about the fluctuations of the economic state variable affect equilibrium demands and prices this results in the endogenous identification of a more complex production function which induces a richer term structure term structures of interest rates in a partially observable economy resemble term structure curves that actual market prices imply this paper also introduces a characteristic function of the term structure and demonstrates that in contrast with a fully observable economy the widely investigated expectations

price changes in the euro area and the united states some facts from individual consumer price data prices of goods and services do not adjust immediately in response to changing demand and supply conditions this paper characterizes the average frequency and size of price changes in the euro area and its member countries investigates the determinants of the probability of price changes and compares the evidence for the euro area with available u s results the facts documented in this paper are based on evidence from individual price data recorded at the store level in all euro area countries except ireland and greece that is in datasets covering austria belgium finland france germany italy luxembourg the netherlands portugal and spain which together account for around 97 percent of euro area gdp the data used are the monthly price records underlying the computation of national consumer price indices and harmonized consumer price indices these data cover a large number of products selected on the basis of extensive household budget surveys

closely competing firms and price adjustment some findings from an online marketplace we investigate retailers price setting behavior using a unique dataset containing by the second records of prices offered by closely competing retailers on a major japanese price comparison website first we find that when the average price of a product across retailers falls rapidly the frequency of price adjustments increases and the size of price adjustments becomes larger second we find positive autocorrelation in the frequency of price adjustments implying that there tends to be clustering where price adjustments occur in succession in contrast there is no such autocorrelation in the size of price adjustments these two findings indicate that the behavior of competing retailers is characterized by state dependent pricing rather than time dependent pricing

term premiums in bond returns abstract this paper examines expected returns on u s treasury bills and on u s government bond portfolios expected bill returns are estimated from forward rates and from sample average returns both estimation methods indicate that expected returns on bills tend to peak at eight or nine months and never increase monotonically out to twelve months reliable inferences are limited to treasury bills and thus to maturities up to a year the variability of longer term bond returns preempts precise conclusions about their expected returns

yield spreads as predictors of industrial production expectations on short rates or term premia this paper reconsiders information in the us t bill term structure for predicting movements in real monthly industrial production it is shown that although t bill spreads contain little or no predictive content increases in term premia estimated from a garch m model of the term structure do since these estimated premia are linear functions of the conditional variance of excess returns the implication is that increases in interest rate variability are associated with reductions in industrial production this evidence is robust to the inclusion of the spread between the 10 year tbond yield and one month t bill yields the t bill term structure therefore contains information which is independent of the long end of the term structure

the monotonicity of the term premium another look this paper reexamines existing evidence regarding the monotonicity of the term premium using a recently developed approach for testing inequality constraints we propose and conduct tests for whether the term premium is monotonic and reach different conclusions from those implied by individual t statistics on term premiums even under a bonferroni type adjustment our results generally support mcculloch s 1987 view that the liquidity preference hypothesis remains unrefuted

cyclical demand and the choice of debt maturity this study provides a model in which a supplier s use of short and long term debt depends on the demand for its product the model predicts that suppliers use short term debt to match their assets and liabilities maturities and that their incentive to do so is stronger the larger the term premium the model also predicts that the use of short term debt increases the amplitudes of the supplier s investment production and sales cycles these changes occur because the use of short term debt permits suppliers to match production and sales more closely to the pattern of demand for the final good

costly monitoring financial intermediation and equilibrium credit rationing abstract this paper establishes a link between equilibrium credit rationing and financial intermediation in a model with asymmetrically informed lenders and borrowers costly monitoring and investment project indivisibilities intermediation is shown to dominate borrowing and lending between individuals and these financial intermediaries exhibit several of the important features of intermediaries as we know them equilibrium interest rates and the aggregate quantity of loans respond quite differently to changes in taste and technology parameters depending on whether or not there is rationing in equilibrium

anomalies in intertemporal choice evidence and an interpretation research on decision making under uncertainly has been strongly influenced by the documentation of numerous expected utility eu anomalies behaviors that violate the expected utility axioms the relative lack of progress on the closely related topic of intertemporal choice is partly due to the absence of an analogous set of discounted utility du anomalies we enumerate a set of du anomalies analogous to the eu anomalies and propose a model that accounts for the anomalies as well as other intertemporal choice phenomena incompatible with du we discuss implications for savings behavior estimation of discount rates and choice framing effects

menu costs and phillips curves this paper develops a model of a monetary economy in which individual firms are subject to idiosyncratic productivity shocks as well as general inflation sellers can change price only by incurring a real menu cost we calibrate this cost and the variance and autocorrelation of the idiosyncratic shock using a new u s data set of individual prices due to klenow and kryvtsov the prediction of the calibrated model for the effects of high inflation on the frequency of price changes accords well with international evidence from various studies the model is also used to conduct numerical experiments on the economy s response to various shocks in none of the simulations we conducted did monetary shocks induce large or persistent real responses

information production and the term structure the difference between the forward rate of interest implicit in the term structure of interest rates and the expected future spot rate is usually referred to as a liquidity premium this paper examines the determinants of the liquidity premiums implicit in the term structure of real interest rates using a three date economy with production the sign of the liquidity premium is characterized in terms of the parameters that describe the uncertainty in the economy the results suggest that the liquidity premiums implicit in the real term structure of interest rates may sometimes be negative

an empirical analysis of term premiums using stochastic dominance abstract this paper examines term premiums in u s treasury bill monthly holding period returns several techniques are employed to ascertain whether the observed term premiums are economically meaningful no second order stochastic dominance is found in the first five month maturities when a riskless asset is assumed the first two maturities are dominated therefore we conclude that although there are statistically significant term premiums they are not economically meaningful if there is no riskless borrowing and lending the term premiums are economically meaningful in the sense that the longer maturities dominate the shorter maturities when a riskless asset is available

a nonlinear general equilibrium model of the term structure of interest rates abstract we derive and test an alternative closed form general equilibrium model of the term structure within the cox ingersoll and ross theoretical framework in which yields are nonlinear functions of the risk free rate we show that equilibrium bond prices and the risk free rate are not always inversely related and that bond risk need not be strictly increasing in maturity using hansen s generalized method of moments to obtain parameter estimates this nonlinear model outperforms the cox ingersoll and ross square root model in describing actual treasury bill yields for the 1964 1986 period

tax induced bias in forward rates term premiums and the term structure of interest rates abstract this paper s analysis on the tax induced bias in forward rates enables us to better understand the structure of term premiums and the term structure of interest rates and to obtain a better estimate of the future interest rate in particular the anomaly of negative term premiums regarding long maturities as reported by fama 1984 is resolved

japan s financial deregulation and linkage of the gensaki and euroyen deposit markets summary this paper examines whether japan s financial deregulation weakened the linkage between the euroyen and gensaki markets it defines and analyses the linkage of the two markets in terms of the persistence and predictability of yield spreads as well as cross market causality by using johansen tests and an error correction model this paper shows first cross market causality before and after deregulation and second one common trend in interest rates substantial gensaki euroyen yield spreads and a slower response of the one month gensaki euroyen yield spread to a shock after deregulation

do stationary risk premia explain it all evidence from the term structure abstract predictable variations in excess returns have often been attributed to the presence of time varying risk premia in this paper we use an insight based upon new techniques from time series analysis to test whether stationary risk premia can alone explain the behavior of excess returns to long bonds relative to rolling over short rates surprisingly we reject this hypothesis using u s t bill returns we then show that either permanent shocks to the risk premia and or rationally anticipated shifts in the interest rate process could produce anomalous results

financial intermediation business failures and real business cycles in this paper a general equilibrium business cycle model is construct ed that when subjected to real disturbances mimics observed qualita tive comovements among real output money business failures risk pr emia intermediary loans and prices in contrast monetary disturban ces generate cycles that have several inconsistencies with empirical evidence thus providing support for real business cycle theory at th e expense of monetary theories of the business cycle financial inter mediation arises endogenously in the model and intermediation matters for business cycle behavior a credit supply mechanism acts in tande m with an intertemporal substitution effect in propagating stochastic disturbances copyright 1987 by university of chicago press

the empirical implications of the cox ingersoll ross theory of the term structure of interest rates the one factor version of the cox ingersoll and ross model of the term structure is estimated using monthly quotes on u s treasury issues trading from 1952 through 1983 using data from a single yield curve it is possible to estimate implied short and long term zero coupon rates and the implied variance of changes in short rates analysis of residuals points to a probable neglected tax effect the term structure of interest rates is important to economists because the relationship among the yields on default free securities that differ in their term to maturity reflects the information available to the market about the future course of events the expectations hypothesis the liquidity preference hypothesis hicks 10 and the market segmentation hypothesis culbertson 6 are theories of the term structure that predict little more than that the implied forward rate is either equal to or not equal to the expectation of future spot rates cox ingersoll and ross 5 cir model the term structure of interest rates in a competitive equilibrium context their model has elements in common with the earlier hypotheses of the term structure however the cir model has a rich class of empirical implications not only for the pricing of default free securities but also for the pricing of bond options callable bonds and other types of financial claims this paper examines the extent to which the model in its simplest one factor form is descriptive of the prices of u s treasury bills bonds and notes traded from 1952 to 1983 section i describes the model and the parsimonious representation of bond prices which it implies section ii describes the data and section iii outlines the preliminary results obtained by fitting the model to observed data the final section outlines directions for future research

inflation bets on the long bond the liquidity premium theory of interest rates predicts that the treasury yield curve steepens with inflation uncertainty as investors demand larger risk premiums to hold long term bonds by using the dispersion of inflation forecasts to measure this uncertainty we find the opposite since the prices of long term bonds move more with inflation than short term ones investors also disagree and speculate more about long maturity payoffs with greater uncertainty shorting frictions measured by using treasury lending fees then lead long maturities to become overpriced and the yield curve to flatten we estimate this inflation betting effect using time variation in inflation disagreement and treasury supply

financial intermediation and delegated monitoring this paper develops a theory of financial intermediation based on minimizing the cost of monitoring information which is useful for resolving incentive problems between borrowers and lenders it presents a characterization of the costs of providing incentives for delegated monitoring by a financial intermediary diversification within an intermediary serves to reduce these costs even in a risk neutral economy the paper presents some more general analysis of the effect of diversification on resolving incentive problems in the environment assumed in the model debt contracts with costly bankruptcy are shown to be optimal the analysis has implications for the portfolio structure and capital structure of intermediaries

nonlinear mean reversion in the term structure of interest rates abstract the expectations hypothesis implies that the yield curve provides information on the future change in the short term interest rate however transaction costs exist in the financial market which prevent investors from realizing the arbitrage opportunity when the arbitrage does not fully cover the transaction costs the purpose of this paper is to assess the effect of transaction costs on the predictability of the term structure by using the threshold vector error correction model which allows for the nonlinear adjustment to the long run equilibrium relationship a significant amount of threshold effect is found and the adjustment coefficients are regime dependent the empirical result supports the nonlinear mean reversion in the term structure of interest rates

an empirical analysis of term premiums using significance tests for stochastic dominance abstract the economic significance of term premiums in real returns on us treasury bills is examined using recently developed tests for first and second order stochastic dominance the tests place only general restrictions on the preferences of individuals and on the distribution of returns the results indicate that the two month real return is preferred to the one month real return based on both dominance criteria other term premiums do not appear to be economically significant

reset price inflation and the impact of monetary policy shocks abstract many business cycle models use a flat short run phillips curve due to time dependent pricing and strategic complementarities to explain fluctuations in real output but in doing so these models predict unrealistically high persistence and stability of us inflation in recent decades we calculate reset price inflation based on new prices chosen by the subsample of price changers to dissect this discrepancy we find that the models generate too much persistence and stability both in reset price inflation and in the way reset price inflation is converted into actual inflation our findings present a challenge to existing explanations for business cycles jel e31 e52

non linearities and nominal contracting effects the case of the depreciation tax shield abstract this paper shows that the effect of nominal contracting on stock returns may be more important than previously believed when information on the maturity structure of depreciation tax shields is incorporated into tests of the nominal contracting hypothesis nominal contracting effects that are not otherwise detectable become so additionally the proportion of stock return variation explained by nominal contracting effects and the aggregate effect on stock returns of depreciation tax shield revaluations are found to be greater than previously believed

nonparametric modeling of u s interest rate term structure dynamics and implications on the prices of derivative securities this paper develops a nonparametric model of interest rate term structure dynamics based on a spot rate process that permits only positive interest rates and a market price of interest rate risk that precludes arbitrage opportunities both the spot rate process and the mar ket price of interest rate risk are nonparametrically specified so that the model allows for maximal flexibility in fitting into the data marginal density of interest rates and historical term structure data are exploited to provide robust estimation of the nonparametric term structure model the model is implemented using u s data and the estimation results are compared to those in the available literature empirical results not only provide strong evidence that most traditional spot rate models and market prices of interest rate risk are misspecified but also confirm that the nonparametric model generates significantly differ ent term structures and prices of common derivatives

five facts about prices a reevaluation of menu cost models are price decreases 3 the frequency of price increases covaries strongly with inflation whereas the frequency of price decreases and the size of price increases and price decreases do not 4 the frequency of price change is highly seasonal it is highest in the first quarter and then declines 5 we find no evidence of upwardsloping hazard functions of price changes for individual products we show that the first second and third facts are consistent with a benchmark menu cost model whereas the fourth and fifth facts are not

exploiting the conditional density in estimating the term structure an application to the cox ingersoll and ross model we propose an empirical method that utilizes the conditional density of the state variables to estimate and test a term structure model with known price formulae using data on both discount and coupon bonds the method is applied to an extension of a two factor model due to cox ingersoll and ross 1985 cir our results show that estimates based on only bills imply unreasonably large price errors for longer maturities we reject the original cir model using a likelihood ratio test and conclude that the extended cir model also fails to provide a good description of the treasury market

a test of the cox ingersoll and ross model of the term structure we test the theory of the term structure of indexed bond prices due to cox ingersoll and ross cir the econometric method uses hansen s generalized method of moments and exploits the probability distribution of the single state variable in cir s model thus avoiding the use of aggregate consumption data it enables us to estimate a continuous time model based on discretely sampled data the tests indicate that cir s model for index bonds performs reasonably well when confronted with short term treasury bill returns the estimates indicate that term premiums are positive and that yield curves can take several shapes however the fitted model does poorly in explaining the serial correlation in real treasury bill returns article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

pricing term structure risk in futures markets one period expected returns on futures contracts with different maturities differ because of risk premia in the spreads between futures and spot prices we analyze the expected returns for futures contracts with different maturities using the information that is present in the current term structure of futures prices a simple affine one factor model that implies a constant covariance between the pricing kernel and the cost of carry cannot be rejected for heating oil and german mark futures contracts for gold and soybean futures the risk premia depend on the slope of the current term structure of futures prices while for live cattle futures the evidence is mixed

time varying term premia on u s treasury bills and bonds abstract we use instrumental variables estimation to document variation in ex ante term premia on u s treasury bills and bonds of maturities ranging from two months to twenty years for the april 1959 to december 1989 sample period ex ante term premia are found to be positively related to the ex ante variability in the nominal one month risk free rate of interest significant shifts in the stochastic process generating term premia are documented subsequent to the october 1979 and october 1982 shifts in monetary policy subperiod results document variation in ex ante tenn premia in each of the three monetary regimes

the kinked demand curve a game theoretic approach in a simple model of duopoly firms price moves are modelled as an extensive form game where firms can respond to undercutting without delay when firms are not too dissimilar kinked demand strategies enforcing an arbitrary price may be nash equilibria however these strategies are dominated and perfect equilibrium is unique at the minimum optimal common price rather than implying price rigidity kinked demand strategies are a device for ensuring compliance with a collusive price leadership

price stickiness in ss models new interpretations of old results abstract what is the relation between infrequent price adjustment and the dynamic response of the aggregate price level to monetary shocks the answer to this question ranges from a one to one link calvo g 1983 prices in a utility maximizing framework journal of monetary economics 12 383 398 to no connection whatsoever caplin a spulber d 1987 menu costs and the neutrality of money quarterly journal of economics 102 703 726 the purpose of this paper is to provide a unified framework to understand the mechanisms behind this wide range of results in doing so we propose new interpretations of key results in this area which in turn suggest the kind of ss model that is likely to generate substantial price rigidity among these new interpretations we revisit caplin and spulber s monetary neutrality result we show that when price stickiness is measured in terms of the impulse response function this result is not a consequence of aggregation as is often assumed but is due instead to the absence of price stickiness at the microeconomic level we also show that the selection effect according to which units that adjust their prices are those that benefit the most is neither necessary nor sufficient to account for the higher aggregate flexibility of ss type models compared to calvo models instead the key concept is the contribution of the extensive margin of adjustment to the aggregate price response the aggregate price level is more flexible than suggested by the microeconomic frequency of adjustment if and only if this term is positive

consumption volatility production volatility spot rate volatility and the returns on treasury bills and bonds abstract the study documents a relation between the expected holding period premiums on treasury bills and the ex ante conditional volatilities of consumption spot one month interest rate and industrial production a model portraying the relation as a risk and return phenomenon is presented and tested consistent with the model the coefficients of the relation appear to depend on the sensitivity of the realized premium to the ex post shocks in consumption industrial production and the spot rate the model fits the data better than the traditional term premium models

costly monitoring loan contracts and equilibrium credit rationing this paper develops a model with asymmetrically informed agents and costly monitoring of loan contracts where an equilibrium can exhibit credit rationing borrowers are identical ex ante but some receive loans and others do not in contrast to existing credit rationing theories rationing does not occur here due to inflexible prices adverse selection or moral hazard optimizing behaviour produces a standard debt contract in equilibrium the aggregate quantity of loans and equilibrium interest rates respond differently depending on whether there is rationing in equilibrium

state dependent or time dependent pricing does it matter for recent u s inflation in the 1988 2004 micro data collected by the u s bureau of labor statistics for the cpi price changes are frequent every 4 7 months depending on the treatment of sale prices and large in absolute value on the order of 10 the size and timing of price changes varies considerably for a given item but the size and probability of a price change are unrelated to the time since the last price change movements in aggregate inflation reflect movements in the size of price changes rather than the fraction of items changing price due to offsetting movements in the fraction of price increases and decreases neither leading time dependent models taylor or calvo nor 1 st generation state dependent models match all of these facts some 2 nd generation state dependent models however appear broadly consistent with the empirical patterns

asymmetry in government bond returns is there asymmetry in the distribution of government bond returns in developed countries can asymmetries be predicted using financial and macroeconomic variables to answer the first question we provide evidence for asymmetry in government bond returns in particular for short maturities this finding has important implications for modeling and forecasting government bond returns for example widely used models for yield curve analysis such as the affine term structure model assume symmetrically distributed innovations to answer the second question we find that liquidity in government bond markets predicts the coefficient of skewness with a positive sign meaning that the probability of a large and negative excess return is more likely in a less liquid market in addition a positive realized return is associated with a negative coefficient of skewness or a small probability of a large and negative return in the future

term premiums and the integration of the eurocurrency markets abstract this paper provides comparative evidence on the time variation of expected returns across the term of eurocurrency markets first it is shown that forward spot spreads contain substanial information about future changed in 1 month to 5 year rates both in the eurodollar and eurodm markets next a latent variable model is constructed with different benchmark portfolios across currencies integration implies that the time variation of the benchmark portfolios must be the same across currencies little evidence is found against integration of the eurocurrency markets jel g15 g12

evidence on macroeconomic complementarities this paper provides empirical evidence on macroeconomic complementarities a restriction on the nature of interaction between individuals in a multiagent setting these models imply that activities across agents will be positively correlated that discrete decisions will be synchronized and that disturbances will be magnified and propagated the paper shows that these implications are consistent with aggregate observations as well as some microeconomic evidence further looking at certain historical episodes such as the national industrial recovery act as well as seasonal fluctuations provides additional support for models with macroeconomic complementarities copyright 1996 by mit press

new hope for the expectations hypothesis of the term structure of interest rates survey data on interest rate expectations permit separate testing of the two alternative hypotheses in traditional term structure tests that the expectations hypothesis fails and that expected future interest rates are ex post inefficient forecasts we find that the source of the spread s poor predictions of future interest rates varies with maturity at short maturities the expectations hypothesis fails at long maturities however changes in the yield curve reflect changes in expected future rates one for one an implication of the expectations hypothesis this result confirms earlier findings that long rates underreact to short rates but now it cannot be attributed to term premia if the attractiveness of an economic hypothesis is measured by the number of papers which statistically reject it the expectations theory of the term structure is a knockout most tests beginning with macaulay 1938 find no evidence supporting the expectations hypothesis 1 many cannot even reject statistically the alternative hypothesis that the spread between long and short rates contains no information about future interest rate changes 2 to make matters worse in u s postwar data future long rates tend to rise when short rates are above long rates since the expectations hypothesis would predict that long rates tend to fall the theory often does worse than even the naive model that future interest

bond returns liquidity and missing data this paper examines holding period returns to constant duration portfolios of u s govern ment notes and bonds and measures the return premium generated by liquidity differences in bonds the approach compares constant duration portfolios constructed in two distinct ways one using only bonds issued in the most recent treasury auction one using all other bonds comparisons of the resulting series are made meaningful by choosing narrow du ration ranges in the portfolio formation procedure this in turn induces a missing data problem in the created time series parameters of return distributions are therefore estimated employing a maximum likelihood framework that explicitly accounts for the missing data it is estimated that recently issued bonds are priced to return a premium of around 55 basis points per annum over otherwise equivalent instruments

microeconomic adjustment hazards and aggregate dynamics the basic premise of this paper is that understanding aggregate dynamics requires considering that agents are heterogeneous and that they do not adjust continuously to the shocks they perceive we provide a general characterization of lumpy behavior at the microeconomic level in terms of an adjustment hazard function which relates the probability that a unit adjusts to the deviation of its state variable from its moving target we characterize rich cross sectionally dependent aggregate dynamics generated by nonconstant hazards we present an example based on u s manufacturing employment and job flows and find that increasinghazard models outperform constant hazard partial adjustment models in describing aggregate employment dynamics

expectation puzzles time varying risk premia and dynamic models of the term structure abstract linear projections of returns on the slope of the yield curve have contradicted the implications of the traditional expectations theory this paper shows that these findings are not puzzling relative to a large class of richer dynamic term structure models specifically we match all the key empirical findings reported by fama and bliss 1987 american economic review 77 4 680 692 and campbell and shiller 1991 review of economic studies 58 495 514 among others within large subclasses of affine and quadratic gaussian term structure models additionally we show that certain risk premium adjusted projections of changes in yields on the slope of the yield curve recover the coefficients of unity predicted by the models key to this matching are parameterizations of the market prices of risk that let the risk factors affect the market prices of risk directly and not only through factor volatilities the risk premiums have a simple form consistent with fama s findings on the predictability of forward rates and are also shown to be consistent with interest rate feedback rules used by a monetary authority in setting monetary policy

fiscal policy and the term structure abstract this paper investigates the empirical association between deficits in interest rates it extends the results in plosser 1982 to include the more recent experience the association between a measure of ex ante real rates and deficits is also considered the results largely corroborate the previous results first little or no association between real or nominal interest rates and deficits is found second output and to a lesser extent military spending are found to have a significant association with interest rates

the term structure of very short term rates new evidence for the expectations hypothesis abstract empirical researchers have frequently rejected the expectations hypothesis the expectations hypothesis however has seldom if ever been tested at the extreme short end of the term structure where maturities are measured in days or weeks using overnight weekly and monthly repo rates i find that term rates are almost unbiased estimates of the average overnight rate this evidence provides new support for the expectations hypothesis

a reexamination of traditional hypotheses about the term structure a comment an example of a continuous time economy is given whose general equilibrium term structure of interest rates obeys the expectations hypothesis for continuously compounded interest rates and returns contradicting the 1981 claim by cox ingersoll and ross that such an economy is mathematically impossible this example does not generate exploitable arbitrage opportunities of the type cox ingersoll and ross claim must arise the logarithmic expectations hypothesis as we call it it therefore an acceptable benchmark from which to measure term premia in continuous time term structure modeling the expectations hypothesis eh broadly construed postulates that expected returns on risk free bonds of different maturities are equal or equivalently that appropriately calculated forward interest rates equal expected future spot interest rates in comparing the expected returns on two bonds of different maturities however the returns may be compounded in any of four natural ways continuously to the shorter bond s maturity to the longer bond s maturity or to the nearest available future date it has long been understood that if the eh holds in terms of any one of these methods and if interest rates are stochastic jensen s inequality will in general preclude it from holding in terms of any of the other three in practice the convenience and simplicity of continuously compounded interest rates and returns have led many researchers e g roll 1970 mcculloch 1975 fama 1984 to use the first method and therefore what

the monotonicity of the term premium abstract fama s evidence that the term premium on treasury securities is not monotonically increasing is found to depend entirely on the behavior of bid asked mean returns on 9 and 10 month bills and only during the subperiod 8 64 12 72 when transactions costs as reflected in the bid asked spread are taken into account there is found to be no way to exploit this non monotonicity the anomalous behavior of the quotations is attributed to the treasury s auctions of 9 month bills during the period 9 66 10 72 the hypothesis that the term premium is a monotonically increasing function of maturity remains unrefuted

recent advances in estimating term structure models in the past 10 years increasingly sophisticated statistical techniques have been applied to the estimation of increasingly complex models of the term structure of interest rates in reviewing this literature we highlight the facts that have been established and the key unresolved issues the data indicate that within a wide range of interest rates mean reversion in rates is at best weak whether mean reversion is stronger for very high or very low levels of rates is an unresolved issue the absolute volatility of rates increases as the level of rates increases but the strength of this effect and the role and nature of either stochastic volatility or regime switching components in rates are still unclear unfortunately these unresolved issues have important implications for fixed income option pricing and risk measurement including value at risk calculations

do forecast errors or term premia really make the difference between long and short rates abstract forward rates in the term structure of interest contain predictions of future spot rates plus possibly term premia realized spot rates contain predicted spot rates plus forecast errors under rational expectations forecast errors are not predictable by forecasting spot rates using publicly available information bounds on the variation of forecast errors and term premia are obtained for one month treasury bill rates one to two thirds of the variation in the difference between forward rates and realized spot rates is due to variation in term premia

why are prices sticky the dynamics of wholesale gasoline prices the menu cost interpretation of sticky prices implies that the probability of a price change should depend on the past history of prices and fundamentals only through the gap between the current price and the frictionless price we find that this prediction is broadly consistent with the behavior of nine philadelphia gasoline wholesalers nevertheless we reject the menu cost model as a literal description of these firms behavior arguing instead that price stickiness arises from strategic considerations of how customers and competitors will react to price changes

frequency of price adjustment and pass through we empirically document using u s import prices that on average goods with a high frequency of price adjustment have a long run pass through that is at least twice as high as that of low frequency adjusters we show theoretically that this relationship should follow because variable mark ups that reduce long run pass through also reduces the curvature of the proflt function when expressed as a function of the cost shocks making the flrm less willing to adjust its price lastly we quantitatively evaluate a dynamic menu cost model and show that the variable mark up channel can generate signiflcant variation in frequency equivalent to 37 of the observed variation in the data on the other hand the standard workhorse model with constant elasticity of demand and calvo or state dependent pricing has di culty matching the facts

capital accumulation under different financial agreements abstract this paper develops a simple overlapping generations model where agents income is given both by a stochastic endowment and by the profits generated by a production activity the purpose is to analyze the consequences of different forms of financial agreements on capital accumulation in this model pareto optimality requires that the capital stock is a deterministic function of the previous level of capital agents can eliminate any randomness in the capital accumulation process when contingent claims markets are available when standard loan contracts prevail because of asymmetric information the economy incurs an efficiency loss due to capital stock fluctuations the expected level of capital under this last regime is always smaller than the one achieved when markets for contingent claims exist

the volatility of short term interest rates an empirical comparison of alternative models of the term structure of interest rates we estimate and compare a variety of continuous time models of the short term riskless rate using the generalised method of moments we find that the most successful models in capturing the dynamics of the short term interest rate are those that allow the volatility of interest rate changes to be highly sensitive to the level of the riskless rate a number of well known models perform poorly in the comparisons because of their implicit restrictions on term structure volatility we show that these results have important implications for the use of different term structure models in valuing interest rate contingent claims and in hedging interest rate risk

the term structure of interest rates in real and monetary economies abstract this paper modifies standard asset pricing models by introducing capital a variable labor supply and money a surprising but very positive result is that in a real production economy the interest rate is close to a random walk this result is found to be true even if there is no persistence in the driving process of the model in this paper we generalize the standard cash in advance constraint by using a shopping time technology this generalization makes it possible to match observed variability for the velocity of money this type of monetary model however is not successful in matching observed behavior of bond prices