the fisher hypothesis and the forecastability and persistence of inflation abstract for the period 1860 to 1939 the simple correlation of the u s commercial paper rate with the contemporaneous inflation rate is 0 17 the corresponding correlation for the period 1950 to 1979 is 0 71 this paper attributes this apparent change in the fisher relation to differences in the stochastic process of inflation rather than a change in any structural relationship between interest rates and expected inflation contrary to recent claims in the literature there is little evidence of inflation non neutrality in data from the pre world war i period

the long run relationship between nominal interest rates and inflation the fisher equation revisited stable url http links jstor org sici sici 0022 2879 28199602 2928 3a1 3c102 3atlrbni 3e2 0 co 3b2 2journal of money credit and banking is currently published by ohio state university press your use of the jstor archive indicates your acceptance of jstor s terms and conditions of use available athttp www jstor org about terms html jstor s terms and conditions of use provides in part that unless you have obtainedprior permission you may not download an entire issue of a journal or multiple copies of articles and you may use content inthe jstor archive only for your personal non commercial use please contact the publisher regarding any further use of this work publisher contact information may be obtained athttp www jstor org journals ohio press html each copy of any part of a jstor transmission must contain the same copyright notice that appears on the screen or printedpage of such transmission the jstor archive is a trusted digital repository providing for long term preservation and access to leading academicjournals and scholarly literature from around the world the archive is supported by libraries scholarly societies publishers and foundations it is an initiative of jstor a not for profit organization with a mission to help the scholarly community takeadvantage of advances in technology for more information regarding jstor please contact support jstor org http www jstor orgmon aug 27 13 58 08 2007

sunspots currency substitution and inflationary finance abstract this paper explores some issues surrounding inflationary finance of government deficits in a two country world with currency substitution each country s monetary policy is assumed to be subordinate to fiscal policy private agents knowing that the monetary authorities cannot commit themselves to fixed policy rules substitute among the two monies each monetary authority is then forced to accomodate the actions of the fiscal authorities and private agents by setting monetary growth rates consistent with their decisions this framework offers some interesting insights into the behavior of nominal exchange rates and their co movements with relative money supplies and government deficits

the purchasing power of money and nominal interest rates a re examination while it has been known for some time that under uncertainty the original version of the fisher hypothesis is not precisely correct empirical researchers have largely ignored this fact such an omission has possibly resulted in erroneous conclusions concerning other hypotheses most notably the impact of prices on the real economy this paper clarifies some of the previous interpretations of the existing empirical literature and provides a theoretical version of the relation between prices and interest rates empirical tests based on both the livingston survey data and data from time series forecasting models provide support for the fisher effect and the hypothesis that only covariance risk is priced in the treasury bill market one of the basic hypotheses concerning rationality in financial markets is based on statements generally attributed to fisher 18 fisher argued that the nominal or money rate of return on an asset should compensate an investor for his or her required real rate of return and changes in the purchasing power of money for the uncertainty case fisher replaced known purchasing power changes with the expected inflation rate whereas the fisher relationship under certainty is well defined his basic theorem under uncertainty is not precise as fama 15 has argued it is changes in the purchasing power of money not the inflation rate that should concern investors under uncertainty the expected value of one is not by jensen s inequality the inverse of the expected value of the other moreover fama and farber 16 grauer and litzenberger 20 and benninga and protopapadakis 3 have shown that when investors are risk averse the fisher relationship will generally not hold even after adjustment has been made for the distinction between purchasing power changes and the inflation rate in particular these authors show that an adjustment must be made for the fact that the real rate of return on nominal bonds is random while these issues have been discussed in the theoretical literature they have largely been ignored in the empirical work on this topic given the fact that nominal rates do not seem to adjust as rapidly to price changes as fisher hypothesized numerous empirical researchers have expanded the basic fisher model in an attempt to explain this empirical anomaly these extensions include the incorporation of a inflation rate variability and the growth in real output

inflation regimes and the sources of inflation uncertainty this paper develops new time series measures of inflation uncertainty in the united states in the postwar period that account for the prospect of changing inflation regimes the measures are constructed from estimates of a markov switching model for inflation importantly we show that rational forecasts derived from the markov model are consistent with survey measures of inflation expectations our markov model allows us to decompose uncertainty about future inflation into two components a certainty equivalent component that ignores uncertainty about future inflation regimes and a regime uncertainty component that reflects this uncertainty survey measures of inflation uncertainty based on the dispersion of forecasts appear more closely associated to the regime uncertainty component than the certainty equivalent component of inflation uncertainty the regime uncertainty component also appears to have significant explanatory power in forecasting unemployment while the certainty equivalent component does not copyright 1993 by ohio state university press

smuggling non fundamental uncertainty and parallel market exchange rate volatility we explore a model where smuggling and a parallel currency market arise owing to government restrictions that prevent agents from legally holding foreign exchange despite such restrictions agents are able to diversify their savings holding both domestic and parallel foreign cash basing their portfolio allocation on current and prospective parallel exchange rates we attribute movements in parallel rates to non fundamental uncertainty the model generates equilibria with both positive and nega tive parallel premia and correlations between illegal trade and the premium the model has the novel implication that currency speculation drives smuggling affecting real activities in all sectors of the economy jel classification f31

was there a peso problem in the u s term structure of interest rates 1979 1982 during the period following october 1979 through 1982 the u s federal reserve allowed interest rates to fluctuate widely in contrast to its previous policy of targeting these rates in the 1970s the policy was abandoned in 1982 in favor of an operating procedure that reduced the variation in interest rates this paper implements an estimation method to identify from the term structure of eurodollar returns the market s beliefs that the federal reserve may revert to interest rate targeting the model is not rejected and gives plausible estimates of the probability of a switch in monetary regimes copyright 1991 by economics department of the university of pennsylvania and the osaka university institute of social and economic research association

interest rate volatility and the term structure a two factor general equilibrium model we develop a two factor general equilibrium model of the term structure the factors are the short term interest rate and the volatility of the short term interest rate we derive closed form expressions for discount bonds and study the properties of the term structure implied by the model the dependence of yields on volatility allows the model to capture many observed properties of the term structure we also derive closed form expressions for discount bond options we use hansen s generalized method of moments framework to test the cross sectional restrictions imposed by the model the tests support the two factor model there are essentially two approaches to the modeling of the term structure of interest rates in continuous time the equilibrium approach pioneered by

a note on nonstationarity structural breaks and the fisher effect abstract we find empirical evidence that inflation nominal and real interest rates in the us are trend stationary with a structural break in both the unconditional mean and the drift rate of a deterministic trend which occurs shortly after the change in operating procedures of the fed in september 1979 this finding casts some doubts on cointegration tests of the long run fisher effect conducted in recent studies since the results of these tests can be affected by the existence of common structural breaks in the series we propose an alternative test of the fisher effect based on a var representation in appropriately detrended variables we find strong support for the fisher effect both in the medium term and in the long term

inflation and asset returns in a monetary economy postwar u s data are characterized by negative correlations between real equity returns and inflation and by positive correlations between real equity returns and money growth these patterns are closely matched quantitatively by an equilibrium monetary asset pricing model the model also implies negative correlations between expected asset returns and expected inflation and it predicts that the inflationasset return correlation will be more strongly negative when inflation is generated by fluctuations in real economic activity than when it is generated by monetary fluctuations the co movements of real asset returns inflation and money growth have been studied extensively over the past fifteen years table i displays some of the statistical properties of these series using quarterly u s data from 1959 to 1990 note first the significantly negative correlation between real equity returns and inflation note also the negative correlation between inflation and the ex post real return to nominally riskless bonds while this fact is not particularly surprising numerous studies conclude that the correlations between ex ante real asset returns and expected inflation are also negative 2 in contrast to these patterns the correlation between money growth and real equity returns is weakly positive in the data while the correlation between money growth and the real bond return is virtually zero initially these empirical patterns were viewed as anomalies negative correlations between inflation and ex post real stock returns contradict the traditional view that equities ought to act as an inflation hedge 3 negative correlations between expected inflation and ex ante real returns violate the

inferring future volatility from the information in implied volatility in eurodollar options a new approach we study the information content of implied volatility from several volatility specifications of the heath jarrow morton 1992 hjm models relative to popular historical volatility models in the eurodollar options market the implied volatility from the hjm models explains much of the variation of realized interest rate volatility over both daily and monthly horizons the implied volatility dominates the garch terms the glosten et al 1993 type asymmetric volatility terms and the interest rate level however it cannot explain that the impact of interest rate shocks on the volatility is lower when interest rates are low than when they are high article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

speculation incomplete currency market participation and nonfundamental movements in nominal and real exchange rates abstract this paper studies possible nonfundamental movements in nominal and real exchange rates arising from a world economy with speculation incomplete participation in international currency markets and nontraded goods the model is capable of generating equilibria which display comovements in nominal and real exchange rates not unlike those observed in actual economies

survey measures of risk aversion and prudence this paper utilizes a thought experiment conducted by the bank of italy to estimate absolute and relative risk aversion along with absolute and relative prudence for a broad cross section of italian households upper and lower bounds are calculated for each parameter and comparisons are made across socio demographic groups evidence is found of decreasing absolute risk aversion decreasing absolute prudence increasing relative risk aversion and increasing relative prudence

the informational content of implied volatility implied volatility is widely believed to be informationally superior to historical volatility because it is the markets forecast of future volatility but for s p 100 index options the most actively traded contract in the united states we find implied volatility in aggregate and across subsamples separated by maturity and strike price implied volatility has virtually no correlation with future volatility and it does not incorporate the information contained in recent observed volatility article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

bond pricing and the term structure of interest rates a new methodology for contingent claims valuation this paper presents a unifying theory for valuing contingent claims under a stochastic term structure of interest rates the methodology based on the equivalent martingale measure technique takes as given an initial forward rate curve and a family of potential stochastic processee for its subsequent movements a no arbitrage condition restricts this family of processes yielding valuation formulae for interest rate sensitive contingent claims which do not explicitly depend on the market prices of risk examples are provided to illustrate the key results in relation to the term structure of interest rates arbitrage pricing theory has two purposes the first is to price all zero coupon default free bonds of varying maturities from a finite number of economic fundamentals called state variables the second is to price all interest rate sensitive contingent claims taking as given the prices of the zero coupon bonds this paper presents a general theory and a unifying framework for understanding arbitrage pricing theory in this context of which all existing arbitrage pricing models are special cases in particular vasicek 1977 brennan and schwartz 1979 langetieg 1980 ball and torous 1983 ho and lee 1986 schaefer and schwartz 1987 and artzner and delbaen 1988 the primary contribution of this paper however is a new methodology for solving the second problem i e the pricing of interest rate sensitive contingent claims given the prices of all zero coupon bonds the methodology is new because i it imposes its stochastic structure directly on the evolution of the forward rate curve ii it does not require an inversion of the term structure to eliminate the market prices of risk from contingent claim values and iii it has a stochastic spot rate process with multiple stochastic factors influencing the term structure the model can be used to consistently price and hedge all contingent claims american or european on the term structure and it is derived from necessary and more importantly sufficient conditions for the absence of arbitrage the arbitrage pricing models of vasicek 1977 brennan and schwartz 1979 langetieg 1980 and artzner and delbaen 1988 all require an iformerly titled bond pricing and the term structure of interest rates a new methodology

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

a model of the term structure of interest rates in an open economy with regime shifts abstract this paper presents a term structure model driven by three factors the foreign real interest rate the domestic inflation rate and the real exchange rate the model is designed to capture effects originating from exchange rate fluctuations and actions by central banks special attention is paid to regime shifts such as changes in the target inflation rate and devaluations an interesting result is that imperfect credibility of a target zone for the exchange rate mainly affects short term interest rates whereas a loss in an inflation target s credibility is likely to increase long term interest rates jel e43 f3 1997 elsevier science ltd

evidence on the varying effect of expected inflation on interest rates boskin michael j mark gertler and charles taylor the impact of inflation on u s productivity and international competitiveness washington d c national planning association 1980 carlton dennis w the disruptive effect of inflation on the organization of markets in robert e hall ed inflation causes and effects chicago the university of chicago press 1982 fama eugene short term interest rates as predictors of inflation american economic review 65 june 1975 269 282 freund william c and paul b manchester productivity and inflation in john d hogan ed dimensions of productivity research vol i houston american productivity center 1980 53 71 geweke john richard meese and warren t dent comparing alternative tests of causality in temporal systems analytic results and experimental evidence journal of econometrics 21 feb 1983 161 194 granger c w j investigating causal relations by econometric models and cross spectral methods econometrica 37 july 1969 424 438 guilkey david k and michael k salemi small sample properties of three tests for granger causal ordering in a bivariate stochastic system this review 64 nov 1982 668 680 houthakker hendrik s growth and inflation analysis by industry brookings papers on economic a ctivity 1979 241 256 hsiao cheng autoregressive modelling and money income causality detection journal of monetary economics 7 1981 85 106 autoregressive modeling and causal ordering of economic variables journal of economic dynamics and control 4 1982 243 259 jarrett j peter and jack g selody the productivity inflation nexus in canada 1963 1979 this review 64 aug 1982 361 367 kendrick john w and elliot s grossman productivity in the united states trends and cycles baltimore the johns hopkins university press 1980 sims christopher a money income and causality american economic review 62 sept 1972 540 552 u s department of commerce bureau of economic analysis the national income and product accounts of the united states 1929 76 statistical tables washington d c superintendent of documents 1981 u s department of labor bureau of labor statistics tables headed industry analytical ratios for the business sector all persons indexes 1977 100 and basic industry data for the business sector all persons printout dated april 27 1983

do call prices and the underlying stock always move in the same direction this article empirically analyzes some properties shared by all one dimensional diffusion option models using sp options are not redundant securities nor ideal hedging instruments puts and the underlying asset prices may go down together much of the extant knowledge about option pricing is based on the assumption that the underlying asset price follows a one dimensional diffusion process examples of such option pricing models include the classic black scholes 1973 merton 1973 the cox ross 1976 constant elasticity of variance the ones studied in derman and kani 1994 rubinstein 1994 bergman grundy and wiener 1996 bakshi cao and chen 1997 2000 and dumas fleming and whaley 1998 all models in the one dimensional diffusion class share three basic properties first call prices are monotonically increasing and put prices are monotonically decreasing in the underlying asset price the monotonicity property second as the underlying asset price is the sole source of uncertainty for all of its options option prices must be perfectly correlated with each other and with the underlying asset the perfect

nominal interest rates as indicators of inflation expectations forward interest rates have become popular indicators of inflation expectations theusefulness of this indicator depends on the relative volatilty and the correlation of inflation expectations and expected real interest rates this paper studies u s and u k data using a range of different tools and data sets the forward rate rule perfoms reasonably well in spite of significant movements in the expected real interest rate the reason is that the noise that movements in the expected real interest rate add to the inflation expectations is balanced by a tendency for expected real interest rates and inflation expectations to move in opposite directions

on the superneutrality of money in a stochastic dynamic macroeconomic model abstract this paper explores the robustness of the superneutrality of money result to the introduction of uncertainty while qualitatively superneutrality fails to obtain in our model quantitatively the observed tobin effect is insignificant the equilibrium time paths of real variables are nearly unaffected by changes in the money growth rule we argue that our conclusions reinforce the theoretical case for superneutrality

the stability of the m2 demand function evidence from an error correction model this note presents an error correction model of m2 demand the chow test indicates that the m2 demand function is stable over the sample period 1953q1 to 1991q2 copyright 1993 by ohio state university press

indeterminacy and volatility of exchange rates under imperfect currency substitution i introduction this paper presents a model of exchange rate determination under currency substitution its primary objective is to examine the implications of currency substitution for the behavior of exchange rates in a general equilibrium model under uncertainty the basic framework used here is the cash in advance model of lucas 1982 which is extended to allow for substitution among currencies it is well known that under perfect currency substitution foreign exchange rates may become indeterminate and behave independently of fundamental economic variables the reason is that the objects traded in foreign exchange markets are fiat currencies which unless supported by binding legal tender laws have no fundamental economic value when agents have unrestricted access to currency markets and are free to use any currency as the means of payment currency demands are entirely determined by speculation and consequently equilibrium exchange rates become indeterminate e g see kareken and wallace 1981 increased integration of financial markets reduces the costs and the risks of holding balances in multiple currencies 4 this creates more opportunities for currency substitution and it is reasonable to assume that agents are free to use any currency as the means of the payment in some of their international transactions for example suppose some percentage of transactions involving the u s exports to germany can be paid with either u s dollars or german marks agents will look at the opportunity costs i e u s and german nominal interest rates and expected exchange rate changes to decide what combination of the two currencies to use in these transactions if the potential costs and benefits of holding the two currencies are similar then agents will be indifferent between the two currencies we show that this could lead to exchange rate indeterminacy and nonfundamental volatility and change the effectiveness of monetary policies in our cash in advance framework agents are allowed to use any currency in some of their transactions called unrestricted transactions to make different currencies attractive at different times we allow the governments to follow timevarying monetary policies as a result agents will change their currency holdings to maximize the risk adjusted return on their portfolio subject to the constraint that specific currencies must be used as the means of payment in their restricted transactions 2 to answer specific questions about the behavior of exchange rates we obtain closed form solutions for agents demand functions equilibrium interest rates and the equilibrium exchange rate it turns out that two types of equilibrium exist in the first type the two currencies have different risk return profiles such that agents will prefer to use only one of them in unrestricted transactions in this case the exchange rate will be determined by fundamentals however as a large percentage of transactions become unrestricted the equilibrium exchange rate becomes more volatile under this type of equilibrium the effectiveness of monetary policies are changed currencies of countries that have high nominal interest rates will not be in demand for use in unrestricted transactions 3 this lack of demand means that any increase in the money supply of a high nominal rate country will lead to a larger increase in its rate of inflation and thus a larger reduction in the value of its currency in other words increased currency substitution increases the sensitivity of the currency values to changes in the money supply of high nominal rate countries also we show that as national economies become more integrated and more opportunities for currency substitution arise currencies of countries with high nominal interest rates would decline substantially the reason is that higher opportunity costs are associated with holding these currencies and thus agents will fully take advantage of currency substitution to reduce their holdings of these currencies reducing the value of these currencies

on real interest rate dynamics and regime switching abstract we find evidence of regime switching dynamics in the usa and the uk real interest rates over the period 1881 2003 for the uk there is a regime in which the real interest rate displays a relatively stronger mean reversion and a regime in which it displays a relatively weaker mean reversion the former regime is characterized by a relatively larger error in the estimation of the reversion parameter and higher volatility for the usa the two regimes differ in volatility the probability of transition from one regime to another is found to be significantly related to the inflation rate regime and to the political regime the results highlight the importance of regime switching in the dynamics of the real interest rate as well as the role of inflation and political regimes in explaining this switching

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

inflation taxation and interest rates this paper demonstrates that the response of nominal interest rates to changes in inflationary expectations should lie between that predicted by the fisher and darby effects the exact nature of the response will depend on the relative size of the income and capital gains tax rates and the relative size of the derivatives of investment and savings to their respective after tax real rates the other major conclusion of this paper is that capital gains taxation offsets the negative effect on investment produced by treating depreciation on a historic rather than a replacement cost basis in the 1960s and early 1970s the economics profession and the financial community increasingly accepted irving fisher s analysis of the effect of changes in anticipated inflation on the rate of interest in the last several years darby 4 and feldstein 5 have elaborated fisher s theory and have arrived at the conclusion that in a world with taxes an increase in inflationary expectations should result in a more than proportional increase in the nominal rate of interest since investors base their investing and saving decisions on the after tax and not the pretax expected consequences of their actions darby 4 has argued that if income taxes are proportional at rate t and interest receipts are taxable and interest payments are tax deductible the real after tax interest rate is

the time series properties of norwegian inflation and nominal interest rate this article investigates the time series properties of norwegian inflation and nominal interest rate using annual data from 1850 to 2004 a number of different univariate unit root tests are employed to examine whether the time series are mean reverting or generated by unit root processes results show very strong evidence in favour of mean reversion in inflation but a unit root in the nominal interest rate this implies that there exists no long run relationship between these two variables a conclusion which is further supported by cointegration tests and estimated vector error correction models the cointegration analysis also points to an important potential pitfall when using cointegration techniques on systems where some variables are stationary processes

the causal effect of mortgage refinancing on interest rate volatility empirical evidence and theoretical implications this article investigates the effects of mortgage backed security mbs hedging activity on interest rate volatility and proposes a model that takes these effects into account an empirical examination suggests that the inclusion of information about mbss considerably improves model performance in pricing interest rate options and in forecasting future interest rate volatility the empirical results are consistent with the hypothesis that mbs hedging affects the interest rate volatility implied by both options and the actual interest rate volatility the results also indicate that the inclusion of information about the mbs universe may result in models that better describe the price of fixed income securities

the long run fisher effect can it be tested empirical support for the long run fisher effect a hypothesis that a permanent change in inflation leads to an equal change in the nominal interest rate has been hard to come by this paper provides a plausible explanation of why past studies have been unable to find support for the long run fisher effect this paper argues that the necessary permanent change to the inflation rate following a monetary shock has not occurred in the industrialized countries of australia austria belgium canada denmark france germany greece ireland italy japan the netherlands norway sweden switzerland the united kingdom and the united states instead this paper shows that inflation in these countries follows a mean reverting fractionally integrated long memory process not the nonstationary inflation process that is integrated of order one or larger found in previous studies of the fisher effect applying a bivariate maximum likelihood estimator to a fractionally integrated model of inflation and the nominal interest rate the inflation rate in all seventeen countries is found to be a highly persistent fractionally integrated process with a positive differencing parameter significantly less than one hence in the long run inflation in these countries will be unaffected by a monetary shock and a test of the long run fisher effect will be invalid and uninformative as to the truthfulness of the long run fisher effect hypothesis

forecasting stock return variance toward an understanding of stochastic implied volatilities we examine the behavior of measured variances from the options market and the underlying stock market under the joint hypotheses that markets are informationally efficient and that option prices are explained by a particular asset pricing model forecasts from time series models of the stockreturn process should not have predictive content given the market forecast as embodied in option prices both in sample and out of sample tests suggest that this hypothesis can be rejected using simulations we show that biases inherent in the procedure we use to imply variances cannot explain this result thus we provide evidence inconsistent with the orthogonality restrictions of option pricing models that assume that variance risk is unpriced these results also have implicationsfor optimal variance forecast rules

on the indeterminacy of equilibrium exchange rates in this paper we consider a particular international economic policy regime the laissez faire regime the distinguishing features of which are unrestricted portfolio choice and floating exchange rates and as we show this regime although favored by many economists is not economically feasible it does not have a determinate equilibrium that is an implication of an overlapping generations model more basically it is an implication of the notion that money is wanted only in order to accomplish trades

nonfundamental uncertainty and exchange rates this paper shows that there can be equilibria in which exchange rates display randomness unrelated to fundamentals this is demonstrated in the context of a two currency one good model with three agent types and cash in advance constraints a crucial feature is that the type i agents for i 1 2 must satisfy a cash in advance constraint by holding currency i while type 3 agents can satisfy it by holding either currency it is shown that real allocations vary across the multiple equilibria if markets for hedging exchange risk do not exist and that the randomness is innocuous if complete markets exist

term structure movements and pricing interest rate contingent claims this paper derives an arbitrage free interest rate movements model ar model this model takes the complete term structure as given and derives the subsequent stochastic movement of the term structure such that the movement is arbitrage free we then show that the ar model can be used to price interest rate contingent claims relative to the observed complete term structure of interest rates this paper also studies the behavior and the economics of the model our approach can be used to price a broad range of interest rate contingent claims including bond options and callable bonds

the behavior of the real rate of interest this paper presents new facts regarding the behavior of the ex ante real rate of interest these facts are notably different from conventional wisdom about the cyclical properties of the real rate in particular we find that the ex ante real rate is contemporaneously positively correlated with gdp and positively correlated with lagged cyclical output there is also evidence that high real rates are associated with strong cyclical output one quarter into the future our results generally are not sensitive to the estimation methodology but are quite sensitive to the price series used this sensitivity is especially true for the consumer price index thus we find evidence of specification uncertainty we also find that real rate behavior varies over different sample periods and that the cyclical properties of the ex ante and ex post real rates are not identical therefore inferring ex ante real rate behavior using ex post data is inappropriate this paper presents new facts regarding the behavior of the ex ante real rate of interest these facts are notably different from conventional wisdom about the cyclical properties of the real rate in particular we find that the ex ante real rate is contemporaneously positively correlated with gdp and positively correlated with lagged cyclical output there is also evidence that high real rates are associated with strong cyclical output one quarter into the future stylized facts presented in stock and watson 1999 are exactly the opposite and we investigate the reasons for these differences we do this by looking across a wide variety of constructed real rate series these series are obtained by using a number of different methodologies for estimating expected inflation using several different price series and looking over different time periods our results generally are not sensitive to the estimation methodology but are quite sensitive to the price series used this sensitivity is especially true for the consumer price index cpi thus we

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

money and asset prices in a cash in advance economy an asset pricing model with money introduced via a cash in advance constraint is presented the monetary velocity is variable hence money demand does not obey the trivial quantity equation the effects of disturbances in output and money growth on real balances the price level and interest rates are examined monetary policy has effects on real asset prices the fisher relation and the premium on nominal bonds are discussed the precise role of the timing of information and transactions for properties of price levels and interest rates are clarified

the pricing of options on default free bonds recent developments in the finance literature dealing with the valuation of contingent claims have been triggered by black and scholes 2 with their valuation of european options on corporate stocks the type of valuation model derived by black and scholes is attractive because it is independent of preferences this independence is possible due to the fact that the contingent claims are usually assumed to be contingent on traded assets or traded state variables for example a european call option is a claim contingent on the value of the corresponding stock to maintain the independence of the claim from preferences however some variables have to be discarded and considered as constants for example the rate of interest which is not a traded state variable is considered a constant in most of the literature see black and scholes 2 merton 11 and ingersoll 9 though this approximation might not cause important discrepancies in the case of corporate liabilities and options on corporate liabilities the effect of such an approximation on the value of default free bonds and options on default free bonds is more important since these liabilities depend only on the rate of interest

stock prices and volume the authors undertake a comprehensive investigation of price and volume co movement using daily new york stock exchange data from 1928 to 1987 they adjust the data to take into account well known calendar effects and long run trends to describe the process they use a seminonparametric estimate of the joint density of current price change and volume conditional on past price changes and volume four empirical regularities are found 1 positive correlation between conditional volatility and volume 2 large price movements are followed by high volume 3 conditioning on lagged volume substantially attenuates the leverage effect and 4 after conditioning on lagged volume there is a positive risk return relation article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

the global configuration of a speculative trading operation an empirical study of foreign exchange trading this paper proposes a theory of firm boundaries based on fore knowledge development and exploitation in speculative or informed trading foreign exchange trading provides this study s empirical context from research on information economics we suggest optimal speculative trading operations are multiunit and globally dispersed alternatively transaction cost economics suggests atomistic actors prevail in the market for fungible commodities like currencies we also develop competing hypotheses about information technology s effects on foreign exchange trading operations speculation arguments predict that the global scope of trading operations will expand after the introduction of generic information technologies transaction cost economics proposes that when atomistic actors do not prevail trading operations will contract after this introduction we test competing predictions with models of the expansion contraction and net change in a firm s global dispersion we estimate these models with data from the population of banks worldwide engaged in interbank foreign exchange currency fx trading from 1974 to 1993 our results uncover two types of firms those that approach the atomistic actor of transaction cost economics and those that resemble the globally dispersed multiunit configuration from our speculation discussion these results encourage reflection on how the theory of the firm differs when firms trade to produce versus speculate

forward contracts and futures contracts abstract this paper provides a detailed discussion of the similarities and differences between forward contracts and futures contracts under frictionless markets and continuous trading simple arbitrage arguments are invoked to value forward contracts to relate forward prices and spot prices and to relate forward prices and futures prices we also argue that forward prices need not equal futures prices unless default free interest rates are deterministic

interpreting the movements in short term interest rates this article uses modern asset pricing theory to examine the behavior of short term nominal interest rates over the past twenty five years the analysis investigates whether variation in the stochastic behavior of consumption growth and inflation can explain movements in the rate of interest the model estimated allows for taste shocks to utility the authors results reveal that much of the month to month movement in nominal interest rates reflects changes in the real rate and the risk premia in addition to inflationary expectations copyright 1992 by university of chicago press

are tax effects important in the long run fisher relationship evidence from the municipal bond market are nominal bonds appropriately discounted for taxes empirical estimnates of the response of nominal interest rates to changes in inflation the fisher effect have failed to produce a definitive answer four reasons have been put forward as possible explanations i tobin effects ii fiscal illusion iii peso problems and iv different estimators utilizing data on taxable and tax exempt bond interest rates and several different estimators we find that the fisher effect estimates are always larger for the taxable bond relative to the tax exempt bond suggesting that fiscal illusion and different estimators cannot account for the previous results how economic agents respond to the tax burdens of assets with different tax treatment is an important issue at both the level of the individual micro and the aggregate economy macro one clear source of evidence would appear to be the market for high quality debt trading in both taxable and tax exempt debt occurs on a daily basis the response of the rates of return on taxable and tax exempt debt to changes in expected inflation are described by the fisher relationship the fisher relationship is one of the oldest equilibrium relationships in financial economics fisher s original proposition was that if the real rate of interest is relatively constant over time a fully perceived change in the purchasing power of money as proxied by the inverse of the rate of inflation would be accompanied by a proportional increase in the nominal interest rate darby 1975 points out that when nominal interest income is taxed as are interest payments on u s treasury bills the fisher relationship implies a response from nominal interest rates that is greater than the change in expected inflation in order to maintain the constant ex ante real interest rate summers 1983 suggests that given average marginal tax rates in the united states the appropriate value of the fisher effect is 1 3 to 1 5 for tax exempt bonds the original fisher specification should be a good approximation implying a fisher effect close to unity in a seminal paper fama 1975 presents evidence to support the hypothesis that changes in nominal

nonlinearity and stationarity of inflation rates evidence from the euro zone countries earlier studies hardly reject the hypothesis of a unit root in inflation few studies have examined the possibility of nonlinearity in inflation and tested nonlinear stationarity of the inflation rates this study thus intends to fill the gap this study utilizes the tests for nonlinearity along with the unit root tests that allow for nonlinearity in the variables to examine the stationarity of inflation rates of 12 european countries that formed the euro zone ez later in the sample period the results suggest that the majority of these countries inflation rates can be characterized by mean reversion during the floating exchange rate period many of them appear to be nonlinear stationary this finding is essential in conducting applied economic studies for these countries when constructing models whose validity relies on whether or not inflation is stationary the results of this study also imply that shocks to inflation have a transitory effect on inflation in the euro area therefore it would be le

inflation real returns and capital investment we find evidence for the hypothesis of mundell 1963 and tobin 1965 that the expected real return component of interest rates is negatively related to the expected inflation component in the mundell tobin model the variation in expected real returns is caused by the variation in expected inflation our evidence suggests however that the variation in expected real returns is more fundamentally an outcome of the capital expenditures process equilibrium expected real returns vary directly with capital expenditures in order to induce equilibrium allocations of resources between consumption and investment this positive relation between expected real returns and real activity which comes out of the real sector combines with a negative relation between expected inflation and real activity which is traced to the monetary sector thus inducing the negative relation between expected inflation and expected real returns predicted by mundell and tobin but explained in terms of a model much different from theirs

understanding the fisher equation it is argued that univariate long memory estimates based on ex post data tend to underestimate the persistence of ex ante variables and hence that of the ex post variables themselves because of the presence of unanticipated shocks whose short run volatility masks the degree of long range dependence in the data empirical estimates of long range dependence in the fisher equation are shown to manifest this problem and lead to an apparent imbalance in the memory characteristics of the variables in the fisher equation evidence in support of this typical underestimation is provided by results obtained with inflation forecast survey data and by direct calculation of the finite sample biases to address the problem of bias the paper introduces a bivariate exact whittle bew estimator that explicitly allows for the presence of short memory noise in the data the new procedure enhances the empirical capacity to separate low frequency behaviour from high frequency fluctuations and it produces estimates of long range dependence that are much less biased when there is noise contaminated data empirical estimates from the bew method suggest that the three fisher variables are integrated of the same order with memory parameter in the range 0 75 1 since the integration orders are balanced the ex ante real rate has the same degree of persistence as expected inflation thereby furnishing evidence against the existence of a fractional cointegrating relation among the fisher variables and correspondingly showing little support for a long run form of fisher hypothesis copyright 2004 john wiley sons ltd

what fisher knew about his relation we sometimes forget abstract expected consumption growth increases the real interest rate as one tries to smooth consumption over time we demonstrate that placing it in the fisher relation 1 is consistent with the euler equation governing the purchase of nominal bonds 2 explains observed procyclicality of the real interest rate 3 is supported empirically and 4 provides an alternative method for estimating the consumer s degree of relative risk aversion

short rate nonlinearities and regime switches abstract using non parametric estimation methods various authors have shown distinct non linearities in the drift and volatility function of the us short rate which are inconsistent with standard affine term structure models we document how a regime switching model with state dependent transition probabilities between regimes can replicate the patterns found by the non parametric studies to do so we use data from the uk and germany in addition to us data and include term spreads in some of our models we also examine the drift and volatility function of the term spread

exchange rate volatility in an equilibrium asset pricing model this paper analyzes a stochastic model of exchange rate determination with unrestricted access to capital and currency markets it is shown that the only restriction imposed by the model on the equilibrium exchange rate is that it satisfy a martingale property this implies that for a given real equilibrium allocation which is optimal the model can display varying amounts of exchange rate volatility and that volatility is unrelated to the welfare properties of the equilibrium allocation whether or not volatility is excessive therefore depends on which equilibrium is chosen as the basis for comparison copyright 1990 by economics department of the university of pennsylvania and the osaka university institute of social and economic research association

the limitation of monotonicity property of option prices an empirical evidence many option pricing models are based on the assumption that the underlying asset price follows one dimensional diffusion process an alternative approach is to test the properties that should hold for all models based on a given stochastic process for the underlying asset following perignon 2006 we test the empirical validity of the monotonicity property for option prices by collecting all transaction data from 1 july 2006 to 31 december 2006 for option contracts traded on the taiwan futures exchange taifex we find that sampled intraday option prices violate the monotonicity property between 29 97 and 57 of the time and that call and put prices often increase or decrease together we also find evidence to show that the frequent violations of the monotonicity property are to a large extent attributable to microstructure effects and that they arise from rational trading tactics

forecasting the comovements of spot interest rates abstract time varying covariance models are compared in the french and german interest rate markets of the pre euro period a bivariate asymmetric dynamic covariance model with level effect best characterizes the in sample variance covariance dynamics model comparison using economic loss functions raises some doubts with alternative models performing similarly out of sample results show that the variance covariance matrix is best forecasted using a vech model with level effect but no volatility spillover not entirely confirming the in sample evidence simple models using exponentially weighted moving averages of past observations perform similarly to the best bivariate model thus some features required to obtain a good in sample fit do not have additional out of sample forecasting power due to overfitting

money banking and the determination of real and nominal exchange rates the authors consider a model where spatial separation limited communication and stochastic relocation create a role for banks and country specific currencies the same factors also permit a deviation from the law of one price the authors examine how monetary policies influence real and nominal rates of exchange and real and nominal rates of interest under both fixed and flexible exchange rate regimes they also demonstrate that both regimes are characterized by an indeterminacy of both the real and the nominal rate of exchange copyright 1997 by economics department of the university of pennsylvania and the osaka university institute of social and economic research association

dynamics of realized volatilities and correlations an empirical study abstract this study examines two important issues underlying realized volatility and correlation estimators first an empirical inquiry is conducted to assess whether bax and eurodollar futures tick by tick data can be characterized as marked point processes second arma neural network garch bekk and naive volatility and correlation forecasts are compared in an out of sample context when a trader prices an interest rate spread option based on those forecasts and simultaneously delta hedges her position other loss functions are also considered competing volatility forecasts are also compared to implied volatilities

shifting endpoints in the term structure of interest rates abstract this paper links the term structure to perceptions of monetary policy long horizon forecasts of short rates required by no arbitrage term structure models are heavily influenced by the endpoints or limiting conditional forecasts of the short rate process common assumptions that the short rate is mean reverting or contains a unit root are shown to generate unrealistic yield predictions failures occur because these assumptions inadequately account for historical shifts in market perceptions of the policy target for inflation this paper links endpoint shifts to agent learning about shifts in long term policy goals shifting endpoints in short rate processes significantly improve yield predictions

inflation and real interest rates on assets with different risk characteristics given the importance of ex ante real interest rates to economic decision making it is no surprise that much empirical research focuses on them 1 several recent studies find that the ex ante real returns for short term u s treasury securities are not constant and are negatively correlated both with inflation and with nominal interest rates this paper examines the extent to which these findings hold for assets of longer maturity are robust with respect to the choice of price index and are stable over time we expand the set of assets studied to include those of longer maturity both publicly and privately issued for two reasons first their ex ante real returns may differ substantially from that of a short term nominally riskless security second because longer maturity assets have risk characteristics closer to capital their ex ante real returns are potentially more relevant for investment and savings decisions we explore the use of various price indices because the index used in most studies the consumer price index severely overstates inflation during the 1970s as a result of its inappropriate treatment of residential housing costs 2 this overstatement casts doubt on an important finding of previous studies that there are long stretches of time during the 1970s when ex ante real rates are significantly negative given the existence of holding costs for the goods relevant to most price indices and the absence of a riskless real return no arbitrage conditions are violated by a negative ex ante real rate however its persistence is problematical because asset holders are typically assumed to have a positive rate of time preference which ensures a positive ex ante real rate in the long run we find that before 1979 a negative relationship of ex ante real rates both with inflation and with nominal interest rates appears for the longer maturity assets as well as the short term nominally riskless asset indeed the relationship grows

real interest rates and inflation an ex ante empirical analysis we develop a method of measuring ex ante real interest rates using prices of index and nominal bonds employing this method and newly available data we directly test the fisher hypothesis that the real rate of interest is independent of inflation expectations we find a negative correlation between ex ante real interest rates and expected inflation this contradicts the fisher hypothesis but is consistent with the theories of mundell and tobin darby and feldstein and stulz we also find that nominal interest rates include an inflation risk premium that is positively related to a proxy for inflation uncertainty

option pricing where the underlying assets follow a gram charlier density of arbitrary order abstract if a probability distribution is sufficiently close to a normal distribution its density can be approximated by a gram charlier series a expansion in option pricing this has been used to fit risk neutral asset price distributions to the implied volatility smile ensuring an arbitrage free interpolation of implied volatilities across exercise prices however the existing literature is restricted to truncating the series expansion after the fourth moment this paper presents an option pricing formula in terms of the full untruncated series and discusses a fitting algorithm which ensures that a series truncated at a moment of arbitrary order represents a valid probability density while it is well known that valid densities resulting from truncated gram charlier series a expansions do not always have sufficient flexibility to fit all market observed option prices perfectly this paper demonstrates that option pricing in a model based on these densities is as tractable as the far less flexible original model of black and scholes 1973 allowing non trivial higher moments such as skewness excess kurtosis and so on to be incorporated into the pricing of exotic options generalising the gram charlier series a approach to the multiperiod multivariate case a model calibrated to standard option prices is developed in which a large class of exotic payoffs can be priced in closed form furthermore this approach when applied to a foreign exchange option market involving several currencies can be used to ensure that the volatility smiles for options on the cross exchange rate are constructed in a consistent arbitrage free manner

a long run non linear approach to the fisher effect we argue that the empirical failure of the fisher effect found in the literature may be due to the existence of non linearities in the long run relationship between interest rates and inflation we present evidence that for the u s during the 1960 2004 period the fisher relation presents important non linearities we model the long run non linear relationship and find that an estr model for the pre volcker era and an lstr model for the post volcker era are able to control for non linearities and constitute long run co integration vectors monte carlo evidence produces support for the hypothesis that non linearities may also be responsible for the less than proportional coefficients of inflation usually found in the linear specifications

volatility momentum and time varying skewness in foreign exchange returns this article tests a stochastic volatility model of exchange rates that links both the level of volatility and its instantaneous covariance with returns to pathwise properties of the currency in particular the model implies that the return volatility covariance behaves like a weighted average of recent returns and hence switches signs according to the direction of trends in the data this implies that the skewness of the finite horizon return distribution likewise switches sign leading to time varying implied volatility smiles in options prices the model is fit and assessed using bayesian techniques some previously reported volatility results are accounted for by the fitted models the predicted pattern of skewness dynamics accords well with that found in historical options prices

do expected shifts in inflation affect estimates of the long run fisher relation recent empirical studies suggest that nominal interest rates and expected inflation do not move together one for one in the long run a finding at odds with many theoretical models this article shows that these results can be deceptive when the process followed by inflation shifts infrequently we characterize the shifts in inflation by a markov switching model based upon this model s forecasts we reexamine the long run relationship between nominal interest rates and inflation interestingly we are unable to reject the hypothesis that in the long run nominal interest rates reflect expected inflation one for one

dynamics of a floating exchange rate regime we study the full equilibrium dynamics of a two country world economy with a floating exchange rate traded and nontraded goods and explicit modeling of the use of money the resulting exchange rate equation depends on several details of the economic structure such as the supply structure and propensities to spend on various goods although real exchange rate movements have the usual association with the current account the ordinary exchange rate may appreciate or depreciate when there are deficits on current account even when the quantities of money do not change deviations from purchasing power parity and the fisher equation are shown to be the rule rather than the exception

confidence in domestic money and currency substitution i introduction the prevalence of currency substitution cs that is the demand for foreign money by domestic residents has been endemic in several latin american and east european countries as well as some other parts of the world traditional explanations of the phenomenon tend to focus on its association with high levels of domestic inflation foreign money is a convenient hedge against the erosion of purchasing power over time 1 therefore the degrees of cs experienced by different countries are theorized as the consequences of the different monetary policies in those countries in particular a stabilization policy such as a decrease in domestic inflation should lead to a decline or even the elimination of cs this prediction however has not been observed empirically in several instances decreases in inflation to minimal levels subsequent to episodes of high inflation have not reversed the demand for foreign money the persistence or hysteresis in cs has been the subject of many theoretical and empirical studies 2 on the other hand interestingly a complete and rapid elimination of local currency has been rarely observed even with high levels of domestic inflation some theoretical explanations of the observed irreversibility of cs in the literature have focused primarily on the transactions technology associated with the use of two monies guidotti and rodriguez 1992 argue that there are costs associated with switching from the use of one currency to the other once an economy is dollarized these costs deter the switch back to the use of domestic money after inflation has abated uribe 1997 elaborates a similar model of cs hysteresis in which the transactions costs are endogenous in that they are a decreasing function of the aggregate level of cs in the economy sturzenegger 1997 postulates a model in which inflation instigates financial adaptation i e a move away from domestic money to the use of foreign money or other assets and transactions costs associated with cs are assumed to decline with an increase in the denomination of purchases in such a setting certain sectors of the economy become dollarized and reversion to the use of domestic money subseq uent to a decline in inflation need not occur in more general terms dornbuschet al 1990 characterize this process of financial adaptation as a shift in money demand for every rate of inflation there is now a lower demand for domestic money leading to hysteresis alternative explanations of cs have focused on public perceptions regarding various government policies one argument is that stabilization policies such as those leading to a decline in inflation lack credibility and hence are ineffective in rooting out cs melvin and fenske 1992 propose this as one explanation for the persistence of demand for foreign money in bolivia monetary reform in the late 1980s notwithstanding a similar conclusion is reached in clements and schwartz 1993 however this argument may imply that persistence in cs is in all likelihood a transitory phenomenon the demand for domestic money will rise eventually as stabilization policies earn credibility in tandon and wang 1999 yet another government policy the imposition of costly capital controls is brought to bear on the persistence of cs in an inflationary economy in such an environment cs arises and persists from balancing between the expected cost of capital controls associated with foreign currency and the loss in purchasing power associated with inflationary domestic money the principal contribution of the present article is the incorporation of agents subjective expectations and beliefs as the key determinant underlying the relative demand for domestic and foreign currencies we study a model in which the confidence in domestic money is partial as in weil 1987 and bertocchi and wang 1995 and extend the previous analysis to a two money environment

a long run structural macroeconometric model of the uk a new modelling strategy that provides a practical approach to incorporating long run structural relationships suggested by economic theory in an otherwise unrestricted var model is applied to construct a small quarterly macroeconometric model of the uk estimated over 1965q1 1999q4 in nine variables domestic and foreign outputs prices and interest rates oil prices the nominal effective exchange rate and real money balances the aim is to develop a model with a transparent and theoretically coherent foundation tests of restrictions on the long run relations of the model are presented the dynamic properties of the model are discussed and monetary policy shocks identified

efficiency risk aversion and portfolio insurance an analysis of financial asset portfolios held by investors in the united kingdom using data for the united kingdom the author shows that investors in six different wealth ranges hold mean variance efficient portfolios of financial assets this result permits him to estimate coefficients of relative risk aversion for investors in each wealth range the author finds that these coefficients are much higher than most previous studies have found this implies that investors 1 are unwilling to hold risky assets unless they are compensated with a sufficiently high risk premium and 2 are willing to pay for portfolio insurance the general nonavailability of portfolio insurance in the united kingdom appears to indicate a supply side rather than a demand side failure copyright 1996 by royal economic society

the performance of alternative interest rate risk measures and immunization strategies under a heath jarrow morton framework using a monte carlo simulation this study addresses the question of how traditional risk measures and immunization strategies perform when the term structure evolves in a heath jarrow morton 1992 manner the results suggest that for immunization purposes im munization strategies and portfolio formation strategies are more important than interest rate risk measures the performance of immunization strategies depends more on the transaction costs and the holding period than on the risk measures moreover the immu nization performance of bullet and barbell portfolios is not very sensitive to interest rate risk measures

implied volatility functions in arbitrage free term structure models abstract we test six term structure models in the heath jarrow and morton 1992 class using eurodollar futures and options data from 1987 1992 we study the time series of implied interest rate volatilities from these models using one day lagged implied volatilities our one and two parameter models simultaneously price an average of 18 5 options each day with an average absolute error of one and a half to two basis points although the models fit well we document systematic strike price and time to maturity biases for all models we also implement simple trading strategies to test whether the models identify genuine biases

modeling asymmetric comovements of asset returns existing time varying covariance models usually impose strong restrictions on how past shocks affect the forecasted covariance matrix in this article we compare the restrictions imposed by the four most popular multivariate garch models and introduce a set of robust conditional moment tests to detect misspecification we demonstrate that the choice of a multivariate volatility model can lead to substantially different conclusions in any application that involves forecasting dynamic covariance matrices like estimating the optimal hedge ratio or deriving the risk minimizing portfolio we therefore introduce a general model which nests these four models and their natural asymmetric extensions the new model is applied to study the dynamic relation between large and small firm returns article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies