jump diffusion processes and the term structure of interest rates the authors investigate the term structure of interest rates when the underlying state variables and production technologies follow the jump diffusion processes even in some cases where the traditional expectations theory about the term structure is consistent with general equilibrium under diffusion processes the traditional theory is not consistent under jump diffusion processes it is shown that bond prices are strictly higher under jump risks than otherwise and that consumers with logarithmic utility functions will develop hedge portfolios in the presence of jump diffusion a number of continuous time asset pricing models have been derived under stochastic diffusion processes with continuous sample paths see e g black and scholes 2 merton 21 breeden 3 and cox ingersoll and ross 8 however recent empirical studies see e g brown and dybvig 4 feinstone 10 and jarrow and rosenfeld 17 suggest that the underlying processes may follow

futures prices on yields forward prices and implied forward prices from term structure when futures contracts are settled with respect to underlying asset prices received theory suggests that the differences between futures prices and implied forward prices from the term structure are strictly due to marking to market ceteris paribus empirical evidence appears to indicate that such differences are small for contracts with short maturities what happens when the futures contract settles to yields implied by future prices of underlying assets the eurodollar futures contract which is the most actively traded futures contract in the united states settles to yield as opposed to prices this unique settlement feature is shown to imply that the implied forward prices from the libor term structure should differ from the futures prices even in the absence of marking to market differences due to marking to market effect are small they are shown to vary between 2 to 45 basis points less than one half percent of futures prices on the other hand differences between implied forward prices and futures prices are shown to be relatively large

imperfect competition and the keynesian cross abstract this paper presents a simple general equilibrium model in which the only non walrasian feature is imperfect competition in the goods market the model is shown to exhibit various keynesian characteristics in particular as competition in the goods market becomes less perfect the fiscal policy multipliers approach the values implied by the textbook keynesian cross

a comment on price endings when prices signal quality stiving 2000 proposes an interesting model to explain price endings his analysis shows that even when customer demand increases at 9 ending price points certain firms that use high prices to signal quality are more likely to set those prices at round numbers this comment raises two issues about the model first it appears that the original paper imposes a condition that has the effect of eliminating a broad range of legitimate separating equilibria from the analyses second it appears that the original model does not include constraints to ensure that the demand for each market segment will be nonnegative when these constraints on demand are included one obtains different aggregate demand curves which leads to different equilibrium prices using the revised model and analysis we find that 71 of the prices end in 9 and only 12 in 0 this contrasts with only 3 ending in 9 and 58 ending in 0 for the original study therefore 9 endings still prevail even though high prices can be used by firms to signal high quality

market structure and fiscal policy effectiveness in a monopolistic competition macromodel with endogenous market structure the fiscal multiplier is shown to consist of two components the first depicts the response of output to a fiscal expansion through the conventional channels that disregard the role of market imperfections the second component captures the effects of firms market power as well as the policy induced change in market structure the latter effect which has not been taken into account in existing studies is shown to be quite significant in raising the fiscal multiplier even above unity and in improving consumers welfare when the labour market is competitive

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

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

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

pricing claims under garch level dependent interest rate processes this article considers the pricing of interest rate sensitive claims when the underlying interest rate is driven by a two state variable garch process analytical solutions are established for the case when the innovations in the short rate are normal and or chi squared random variables and the volatility of rates take on a special garch form garch models that nest level dependent interest rate models including the cox ingersoll and ross model are also considered algorithms are provided that permit the efficient pricing of american style interest rate claims under a rather broad array of garch level dependent processes

can personal gasoline permit trading be effective an investigation into permit demand this study proposes a personal gasoline permit trading scheme to limit the total gasoline consumption thus reducing its environmental impact we studied the effectiveness of this scheme by analyzing the permit demand of a gasoline driven vehicle in transportation sector a general utility optimization model is formulated and a cobb douglas utility function is further assumed to analyze the response of permit demand to its price changes with the slutsky decomposition of price effects the results when defined in economic terms indicate that the permit demand of consumers in higher income groups are negatively related to permit price permit demand are also negatively related to permit price for consumers in medium income groups but with positive income effect and the direct relationship between permit demand of lower income groups and the price is defined as a giffen good effect that is for those low income groups when the permit price rises their demand for permits would also increase then us and singapore household expenditure data are used to show comparable results of a pilot personal gasoline permit trading scheme further some regulations on critical parameters such as permit allocation and permit prices in the policy design are proposed to make the scheme feasible in different income groups based on these results implications limitation and suggestions for future study are discussed

public capital and imperfect competition abstract in this paper we consider a macroeconomic model in which public capital is a productive input and there is monopolistic competition in the product market we analyze the effects of a permanent variation in public capital investment both in the short and in the long run finally we show that the optimal provision of public capital under imperfect competition is higher than that associated with the first best policy

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

continuous time methods in finance a review and an assessment i survey and assess the development of continuous time methods in finance during the last 30 years the subperiod 1969 to 1980 saw a dizzying pace of development with seminal ideas in derivatives securities pricing term structure theory asset pricing and optimal consumption and portfolio choices during the period 1981 to 1999 the theory has been extended and modified to better explain empirical regularities in various subfields of finance this latter subperiod has seen significant progress in econometric theory computational and estimation methods to test and implement continuous time models capital market frictions and bargaining issues are being increasingly incorporated in continuous time theory the roots of modern continuous time methods in finance can be traced back to the seminal contributions of merton 1969 1971 1973b in the late 1960s and early 1970s merton 1969 pioneered the use of continuous time modeling in financial economics by formulating the intertemporal consumption and portfolio choice problem of an investor in a stochastic dynamic programming setting merton 1973b also showed how such a framework can be used to develop equilibrium asset pricing implications thereby significantly extending the asset pricing theory to richer dynamic settings and expanding the scope of applications of continuous time methods to study problems in financial economics 1 within a span of about 30 years from the publication of merton s inf luential papers continuous time methods have become an integral part of financial economics indeed in certain core areas in finance such as e g asset pricing derivatives valuation term structure theory and portfolio selection continuoustime methods have proved to be the most attractive way to conduct research and gain economic intuition the continuous time approach in these areas has produced models with a rich variety of testable implications the econometric theory for testing continuous time models has made rapid strides in the last decade and has thus kept pace with the impressive progress on the theoretical front one hopes that the actual empirical investigations and estimation using the new procedures will follow suit soon

monopolistic competition as a foundation for keynesian macroeconomic models a general equilibrium macroeconomic model based on monopolistic competition is presented the model exhibits a traditional multiplier in the short run but due to free entry the multiplier disappears in the long run by construction all agents are fully rational the keynesian results are a consequence of the assumption of monopolistic competition which creates a divergence between optimal private behavior and optimal social behavior

inefficient dynamic portfolio strategies or how to throw away a million dollars in the stock market a number of portfolio strategies followed by practitioners are dominated because they are incompletely diversified over time the payoff distribution pricing model is used to compute the cost of following undiversified strategies simple numerical examples illustrate the technique and computer generated examples provide realistic estimates of the cost of some typical policies using reasonable parameter values the cost can be substantial and should not be ignored by practitioners a section on generalizations shows how to extend the analysis to term structure models and other general models of returns this abstract was borrowed from another version of this item

the dynamics of the forward interest rate curve a formulation with state variables the objective of this paper is twofold first the paper develops a class of models of the term structure of interest rates in the heath jarrow and morton 1992 framework with dynamics characterized by the evolution of a small set of state variables second the paper exploits this characterization of the dynamics of the term structure in an estimation exercise that makes use of both the time series and cross section of bond prices in this way our class of models bridges the gap between traditional models such as cox ingersoll and ross 1985 and vasicek 1977 that emphasize the dynamics of interest rates and the models of heath jarrow and morton 1992 that stress fitting the cross section of bond prices

reply to a comment on price endings when prices signal quality although the comment provides some additional insight it in no way diminishes the contribution of the original paper that paper is the first and only theoretical explanation for why firms behave as though they use round prices to signal quality further the paper provides empirical evidence in support of this explanation

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

gaussian estimation of single factor continuous time models of the term structure of interest rates this article presents the first application in finance of recently developed methods for the gaussian estimation of continuous time dynamic models a range of one factor continuous time models of the short term interest rate are estimated using a discrete time model and compared to a recent discrete approximation used by chan karolyi longstaff and sanders 1992a hereafter ckls whereas the volatility of short term rates is highly sensitive to the level of rates in the united states it is not in the united kingdom the econometric estimation of continuous time models of the short term interest rate has been a relatively recent development in empirical finance see for example brown and dybvig 1986 melino and turnbull 1986 barone cuoco and zautzik 1991 babbs 1992 abken 1993 chen and scott 1993 das 1993 gibbons and ramaswamy 1993 pearson and sun 1994 lund 1994 pfann schotman and tschernig 1995 ait sahalia 1995 and broze scaillet and zakoian 1995 1 in an important study chan karolyi longstaff and sanders 1992a hereafter ckls develop a general framework to estimate and compare a range of different single factor term structure models for the short term interest rate their major conclusion is that term structure models with volatilities more highly sensitive to the level of interest rates than more generally used models have a closer empirical fit to the data in addition the functional form of the drift with or without mean reversion is of secondary importance to the correct specification of the conditional heteroskedasticity in ckls the continuous time models of the term structure are estimated using a discrete approximation we present in this article an alternative

the information content in bond model residuals an empirical study on the belgian bond market abstract we estimate daily vasicek cir and spline models on belgian data and compare the trading profits that can be made on the basis of their residuals abnormal returns measured using three different benchmarks are negatively related to once and twice lagged mispricing buying underpriced bonds and especially selling overpriced bonds yields significant abnormal returns even when the trade is delayed by up to five days after observing the mispricing the traditional spline model overfits the data and is least able to detect mispricing large model residuals are more likely to be the result of model misspecification or estimation than are small or medium sized residuals

throwing away a billion dollars the cost of suboptimal exercise strategies in the swaptions market abstract this paper studies the costs of applying single factor exercise strategies to american swap options when the term structure is actually driven by multiple factors using a multifactor string market model of the term structure we find that even when single factor models are recalibrated to match the market at every exercise date the exercise strategies they imply can be suboptimal based on estimates of notional amounts outstanding the total present value costs of following single factor strategies could be several billion dollars these results illustrate the importance of using well specified term structure models

valuing commercial mortgages an empirical investigation of the contingent claims approach to pricing risky debt this paper empirically investigates a contingent claims model of commercial mortgage pricing we find that the magnitude of the observed default premia for a sample of nonprepayable fixed rate bullet mortgages can be explained by the contingent claims model in addition the model explains a significant proportion of the period to period changes in the default premia however given an assumed negative correlation between building value changes and interest rate changes the model s risk structure tends to increase less steeply with increasing maturity than the observed risk structure since the seminal work of black and scholes 1973 corporate liabilities have been modeled as options on the total value of the firm this contingent claims approach to bond pricing was refined by merton 1974 to allow for cash dispersals prior to the bonds maturities and by brennan and schwartz 1980 and ingersoll 1987 to allow for interest rate uncertainty although variants of these bond pricing models are currently being used extensively on wall street they have not been tested extensively moreover empirical studies have not successfully accounted for the observed spread between the rates on risky and default free debt jones mason and rosenfeld 1984 empirically investigate a model that assumes a nonstochastic term structure of interest rates while ramaswamy and sundaresan 1986 examine a model with stochastic interest rates to price floating rate notes in both cases the models could not explain the observed default premia the relative lack of empirical analysis is due partly to the complicated nature of corporate bonds major corporations generally have a large number of different bond issues outstanding that have different priorities in the event that the firm goes bankrupt moreover the bonds can have a variety of covenants specifying sinking fund provisions conditions under which technical default will occur and other restrictions that can have an impact on their value although these complications do not preclude pricing various bond issues on a case by case basis they make it difficult to test systematically the accuracy of the pricing model

profits markups and entry fiscal policy in an open economy in this paper we develop a general model of an imperfectly competitive small open economy there is a traded and non traded sector whose outputs are combined in order to produce a single final good that can be either consumed or invested we make general assumptions about preferences and technology and analyze the impact of fiscal policy on the economy we find that the fiscal multiplier is between zero and one and provide sufficient conditions for it to be increasing in the degree of imperfect competition we also are able to compare the multiplier under free entry and with a fixed number of firms and welfare a simple graphical representation of the model is developed

arbitrage with fixed costs and interest rate models in this paper we study securities market models with fixed costs we characterize the absence of arbitrage opportunities and we provide fair pricing rules we then apply these results to extend some popular interest rate and option pricing models which present arbitrage opportunities in the absence of fixed costs in particular we prove that the quite striking result obtained by dybvig ingersoll and ross 1996 which asserts that under the assumption of absence of arbitrage long zero coupon rates can never fall is no longer true in models with fixed costs even arbitrarily small ones for instance models where the long term rate follows a diffusion process are arbitrage free in the presence of fixed costs including arbitrarily small ones we also rationalize models with partially absorbing or reflecting barriers on the price processes in particular we propose a version of the cox ingersoll and ross 1985 model which as in longstaff 1992 produces yield curves with realistic humps but does not assume an absorbing barrier for the short term rate this is made possible by the presence of even arbitrarily small fixed costs

testing term structure estimation methods evidence from the uk strips market prices and yields of uk government zero coupon bonds are used to test alternative yield curve estimation models zero coupon bonds permit a more pure comparison as the models are providing only the interpolation service and also not making estimation feasible it is found that better yield curves estimates are obtained by fitting to the yield curve directly rather than fitting first to the discount function a simple procedure to set the smoothness of the fitted curves is developed and a positive relationship between oversmoothness and the fitting error is identified a cubic spline function fitted directly to the yield curve provides the best overall balance of fitting error and smoothness both along the yield curve and within local maturity regions

a comparative evaluation of alternative models of the term structure of interest rates abstract in the paper alternative models of the term structure of interest rates are classified in two different approaches the no arbitrage and the general equilibrium approach it is maintained that the general equilibrium approach is superior on a theoretical ground for two main reasons first relevant variables such as the spot interest rate and the interest risk premium are endogenous second the relationship between the real and the financial side of the economy becomes a clear and important element in the understanding of the term structure as regards the applications however the advantages of the general equilibrium over the no arbitrage approach are not so clear the major role in the empiricil performance of alternative models is played by their ability to capture volatility at the current state of the literature there is no model that outperforms others in particular on the empirical side

market structure cost asymmetries and fiscal policy effectiveness abstract imperfectly competitive macroeconomic models typically assume a symmetric equilibrium with identical firms despite the fact that most industries are characterised by substantial degrees of firm heterogeneity we examine how inter firm efficiency gaps affect fiscal policy effectiveness under monopolistic competition

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

cross sectional versus time series estimation of term structure models empirical results for the dutch bond market abstract we compare time series and cross section estimates of the well known vasicek and cir term structure models for a dataset of daily bond prices and short term interest rates for the netherlands the main finding is the great similarity between the two models with respect to the cross sectional term structure parameter estimates and implied bond option values from a time series perspective we find that for some maturities the data reject the constant volatility vasicek model and indicate the presence of the cir volatility effects

price endings when prices signal quality this paper provides a theoretical explanation for why firms behave as though they use round prices to signal quality by replacing the linear demand curve in bagwell and riordan s 1991 price as a signal of quality model with a kinked demand curve and analyzing what price endings firms are most likely to use the following observations can be made 1 firms that are using high prices to signal quality are more likely to set those prices at round numbers and 2 price endings themselves are not necessarily signals of quality a simulation was conducted to demonstrate that these findings generally hold true even in the presence of demand spikes at 9 ending prices e g schindler and kibarian 1996 finally empirical evidence is provided to demonstrate that firms tend to use more round prices for higherquality products and that this relationship is even stronger for product categories where consumers are less able to detect the true level of quality prior to purchase

option prices implied price processes and stochastic volatility this paper characterizes all continuous price processes that are consistent with current option prices this extends derman and kani 1994 dupire 1994 1997 and rubinstein 1994 who only consider processes with deterministic volatility our characterization implies a volatility forecast that does not require a specific model only current option prices we show how arbitrary volatility processes can be adjusted to fit current option prices exactly just as interest rate processes can be adjusted to fit bond prices exactly the procedure works with many volatility models is fast to calibrate and can price exotic options efficiently using familiar lattice techniques

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

a theory of the nominal term structure of interest rates a model of the nominal term structure of interest rates is developed that has a positive and stationary process for the interest rate and delivers closed form expressions for the prices of discount bonds and european options on bonds unlike the one state variable version of the cox ingersoll and ross 1985 model this model even in its one state variable version allows the term premium to change sign as a function of the state and the term to maturity and also allows for shapes of the yield curve that are observed in the u s data but that are disallowed in the cox ingersoll and ross model article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

discounting the distant future how much do uncertain rates increase valuations abstract we demonstrate that when the future path of the discount rate is uncertain and highly correlated the distant future should be discounted at significantly lower rates than suggested by the current rate we then use two centuries of us interest rate data to quantify this effect using both random walk and mean reverting models we compute the certainty equivalent rate that summarizes the effect of uncertainty and measures the appropriate forward rate of discount in the future under the random walk model we find that the certainty equivalent rate falls continuously from 4 to 2 after 100 years 1 after 200 years and 0 5 after 300 years at horizons of 400 years the discounted value increases by a factor of over 40 000 relative to conventional discounting applied to climate change mitigation we find that incorporating discount rate uncertainty almost doubles the expected present value of mitigation benefits

after tax term structures of real interest rates inferences from the uk linked and non linked gilt markets abstract this study estimates the after tax term structure of real interest rates using the prices of uk linked and non linked gilts over the period from 25 january 1986 until 25 october 1993 the impact of differential taxation and the existence of noise in observed market prices is found to produce a significant impact on the parameter estimation of term structure models when compared to methods such as brown and schaefer brown r schaefer s 1994 journal of financial economics 35 1 42 that did not two major observations can be made regarding the estimates for spot real interest rates firstly the volatility of the short term rate is much lower than that found by brown and schaefer 1994 which provides a better fit with the predictions of the cir single factor model for interest rates secondly consistent with rumsey rumsey j 1993 an impact of the assumptions about taxes on the estimation of the properties of interest rates working paper there appears to be some evidence to suggest that single factor interest rate models produce a better fit to interest rates on an after tax basis than on a before tax basis

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

on alternative interest rate processes abstract in this paper alternative interest rate processes are estimated for denmark germany sweden and the uk using the generalized method of moments gmm in line with the study by chan karolyi longstaff and sanders 1992 on us data there seems to be a positive relation between interest rate level and volatility for some countries in contrast to their study it is found that mean reversion plays an important role for the specification of the interest rate dynamics the results seem to be robust to the use of different moment conditions and simulations of the estimated models reveal that they are fairly able to capture non fitted moments as well in addition there is evidence of a structural change in the danish interest rate process in august 1985 which may be due to a change in monetary policy the small sample properties of the gmm estimators are also studied through simulations

no arbitrage conditions for storable commodities and the modeling of futures term structures abstract one distinguishable feature of storable commodities is that they relate to two markets cash market and storage market this paper proves that if no arbitrage exists in the storage cash dual markets the commodity convenience yield has to be non negative however classical reduced form models for futures term structures could allow serious arbitrages due to the high volatility of the convenience yield to avoid negative convenience yield this paper proposes a semi affine arbitrage free model which prices futures analytically and fits futures term structures reasonably well importantly our model prices commodity related contingent claims such as calendar spread options quite differently with classical models

enhancing estimation for interest rate diffusion models with bond prices we consider improving estimating parameters of diffusion processes for interest rates by incorporating information in bond prices this is designed to improve the estimation of the drift parameters which are known to be subject to large estimation errors it is shown that having the bond prices together with the short rates leads to more efficient estimation of all parameters for the interest rate models it enhances the estimation efficiency of the maximum likelihood estimation based on the interest rate dynamics alone the combined estimation based on the bond prices and the interest rate dynamics can also provide inference to the risk premium parameter simulation experiments were conducted to confirm the theoretical properties of the estimators concerned we analyze the overnight fed fund rates together with the u s treasury bond prices supplementary materials for this article are available online

single factor heath jarrow morton term structure models based on markov spot interest rate dynamics this paper considers the class of heath jarrow morton term structure models where the spot interest rate is markov and the term structure at time t is a function of time maturity and the spot interest rate at time t a representation for this class of models is derived and i show that the functional forms of the forward rate volatility structure and the initial forward rate curve cannot be arbitrarily chosen i provide necessary and sufficient conditions indicating which combinations of these functional forms are allowable i also derive a partial differential equation representation of the term structure dynamics that does not require explicit modeling of both the market price of risk and the drift term for the spot interest rate process using the analysis presented in this paper a class of intertemporal term structure models is derived

a model of imperfect competition with keynesian features the recent literature on the reappraisal of keynes has viewed keynesian equilibria as arising when prices are fixed and effective demands and supplies are equilibrated through the adjustment of quantities one problem with this approach is that it lacks a theory of price determination in particular of why prices are fixed in the present paper we show that a number of keynesian features arise in a model in which prices are fully flexible but where agents have some monopoly power one advantage of this approach is that it provides a theory of the determination of both prices and quantities

imperfect competition and crowding out abstract this paper applies the central feature of imperfect competition in the goods market to examine the validity of the standard belief in international macroeconomics namely that policy effects in a small open economy are less effective than in a closed economy it is shown that the profit margin in imperfect competition and marginal propensity to leisure are the key factors in determining whether this standard belief is valid

a spectral temporal index with an application to u s interest rates this article presents a flexible data analytic procedure for calculating spectral temporal indexes by exploiting the duality property between frequency and time domain procedures the approach consists of capturing the interrelationships between the subordinate series across a range of cycles using a principal components decomposition in the frequency domain and transforming this information into the time domain to construct a temporal index the approach is applied to the calculation of an index of u s short and long interest rates the main result of the empirical analysis is that for a broad range of cycles a single index can be used to summarize and synthesize the information contained in a range of interest rates differing in terms to maturity

the dynamically extended keynesian cross and the welfare improving fiscal policy abstract we construct a dynamic keynesian cross the dynamic extension allows for seigniorage on government financing in lieu of lump sum taxation because seigniorage imposes no tax burden expansionary fiscal policy improves welfare even if wasteful

increasing returns and the foundations of unemployment theory current approaches to macroeconomic theory divide roughly into two basic schools of thought one approach typically associated with rational expectations views the economy as basically at or near walrasian market clearing equilibrium in which case it becomes very difficult to explain away convincingly the undeniable persistence at times of involuntary unemployment another approach views the underemployed economy as being in a state of temporary fixed price disequilibrium in which case aside from having to repress suspicions that the essence of effective demand failure might not have to do with prices fixed at wrong values there is a lot of rationalising to be done about why profitable adjustments are so slow this paper argues that something like an internally consistent theory of steady state involuntary unemployment is possible and even plausible the cornerstone of this third approach is increasing returns to scale which blocks unemployed agents from breaking out of a low level equilibrium trap unless there is overall coordination or stimulation a simple model is presented which contains the basic ideas

imperfect competition the keynesian cross and optimal fiscal policy abstract this note analyzes a simple keynesian macro model with imperfect competition and demonstrates that the optimal fiscal policy is a complete shutdown taxes and government purchases should both be zero if the model is extended slightly then welfare improving policies may exist however the benefits are generated in part by the public goods nature of government purchases and not just by the multiplier process it appears that the multiplier alone is not sufficient to justify the use of fiscal policy

pricing interest rate derivatives a general approach the relationship between affine stochastic processes and bond pricing equations in exponential term structure models has been well established we connect this result to the pricing of interest rate derivatives if the term structure model is exponential affine then there is a linkage between the bond pricing solution and the prices of many widely traded interest rate derivative securities our results apply to m factor processes with n diffusions and l jump processes the pricing solutions require at most a single numerical integral making the model easy to implement we discuss many options that yield solutions using the methods of the article

explorations into factors explaining money market returns in this article we measure and interpret the common factors that describe money market returns results are presented for both three and four factor models we find that the three factor model explains on average 86 percent of the total variation in most money market returns while the four factor model explains on average 90 percent of this variation using mimicking portfolios we provide an interpretation of the systematic risks represented by these factors in this article we attempt to measure and interpret the common factors that describe money market returns the factor approach we employ assumes that the covariance matrix of a set of random variables in this case excess returns can be decomposed into common or systematic components and idiosyncratic or nonsystematic components this decomposition into systematic and nonsystematic components is based on an assumption of a linear relationship between the returns of each security and a set of common factors this is the assumption of linear return generating models which form an integral part of the structure of many asset pricing theories for example arbitrage pricing theory apt as developed by ross 1976 the interpretation is that the common factors represent sources of systematic or nondiversifiable risk and the idiosyncratic component of returns represents diversifiable risks our focus here is not on testing a particular asset pricing model per se but on developing empirical evidence for the existence of stylized facts regarding money market returns the stylized facts take the form of the existence measurement and interpretation of the common factors that are found in money markets our attempt to measure and interpret these sources of systematic risk may eventually lead to the construction of observable eco

stochastic processes for interest rates and equilibrium bond prices default free bonds represent in essence money sold forward the investor gives dollars say to the government now in exchange for a contract which promises to pay with probability one a given number of dollars at maturity and possibly a stream of intermediate coupon payments prior to maturity only recently have financial economists begun to examine the pricing of those bonds in a portfolio context in that framework nominal liquidity premiums or risk premiums on long term default free bonds are attributable to uncertainty about taste technological and price level changes which may occur prior to maturity of the bonds and prior to each coupon payment if any to the extent that the investor is unable to diversify away that uncertainty there is a systematic risk attached to the marginal utility which he or she can derive from the use in consumption or investment of the dollar payoffs on the bonds in some term structure models the instantaneous or short term rate of interest denoted here as a function of time t by r t in nominal terms and r t in real terms can be taken as a sufficient statistic1 for the source of systematic uncertainty about the marginal utility of the proceeds to be derived from defaultfree bonds maturing beyond the next instant e g merton 1974 vasicek 1977 cox ingersoll and ross 1977 specific assumptions about tastes technology and utility functions lead to specific equilibrium stochastic processes for the instantaneous short term riskless rate and longer term bond prices which are modelled as functionally dependent upon maturity and that short term riskless rate if a closed form solution exists for the long term bond price as a function of maturity and the short term interest rate it will be conditional inter alia on the parameters of the stochastic process for that short term rate marsh 1981 proposed that the closed form solutions could be tested in terms of the restrictions implied cross sectionally on the parameters of the time series process for the returns or prices of longer term bonds each with a given term to maturity for an analogy outside the term structure literature think of the closed form solution given by black and scholes 1972 for the price of an option on a nondividend paying stock with lognormal price dynamics given the model the cross section of time series for the changes in prices for each of the several options written on the same stock are not unrestricted their dispersion is functionally linked to the same volatility parameter for the stock price thus the option model including

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

valuing swiss default free callable bonds abstract a model to price the call features embedded in swiss riskless callable bonds is developed the model accounts for the time dependent variance of bond returns the specific exercise conditions of this long term non traded call option and the incompleteness of the swiss bond market empirical results show that the call feature s price is particularly sensitive to the riskless rate and variance specifications illiquidity explains some cross sectional call pricing biases found in this study but the underpricing of ordinary versus callable bonds cannot be excluded