industry classifications and return comovement a company s industry affiliation is commonly used to construct homogeneous stock groupings for portfolio risk management relative valuation and peer group comparisons a variety of industry classification systems have been adopted however creating disagreements as to companies industry assignments this analysis of the global industry classification system gics and fama french system indicates that common movement in returns and operating performance resulting from industry effects is stronger for stocks of large companies than for those of small companies also increasingly fine levels of disaggregation improve discrimination up to six digit gics codes after which the benefits tail off stock groupings based on industry exhibit stronger out of sample homogeneity than groups formed from statistical cluster analysis

the asymmetric behavior and procyclical impact of asset correlations abstract this paper examines the behavior of asset correlations with the market returns in the asymptotic single risk factor asrf approach of the basel ii accord on regulatory capital requirement over a sample period from 1988 to 2007 we find that asset correlations are positively related to firm size but negatively related to firm default probability asset correlations are also industry specific as firms in media transportation pharmaceutical and semiconductor industries exhibit higher asset correlations than those in retail and consumer staples most importantly asset correlations are asymmetric and have a procyclical impact on the real economy after controlling for these effects they tend to rise during economic downturns but decline during economic upturns the average magnitude of the rise is larger than that of the decline these findings suggest that asset correlations may be underestimated during economic downturns and may provide policy implications for the capital requirement framework

credit and inflation under borrowerʼs lack of commitment here we investigate the existence of credit in a cash in advance economy where there are complete markets but for the fact that agents cannot commit to repay their debts defectors are banned from the credit market but they can use money balances for saving purposes without uncertainty deflation crowds out credit completely the equilibrium allocation however is efficient if the government deflates at the time preference rate efficiency can also be restored with positive inflation for any non negative inflation rate below the optimal level the volume of credit and the real interest rate increase with inflation our results hold when idiosyncratic uncertainty is introduced and households are sufficiently impatient but in one instance efficiency cannot be restored if the deflation rate is nearby the rate of time preference our numerical examples suggest that the optimal inflation rate is not too large for reasonable levels of patience and risk aversion finally we present a framework where the use of money arises endogenously and show that it is tantamount to our cash in advance framework our results hold in this modified environment

credit risk drivers evaluating the contribution of firm level information and of macroeconomic dynamics abstract understanding if credit risk is driven mostly by idiosyncratic firm characteristics or by systematic factors is an important issue for the assessment of financial stability by exploring the links between credit risk and macroeconomic developments we observe that in periods of economic growth there may be some tendency towards excessive risk taking using an extensive dataset with detailed information for more than 30 000 firms we show that default probabilities are influenced by several firm specific characteristics when time effect controls or macroeconomic variables are also taken into account the results improve substantially hence though the firms financial situation has a central role in explaining default probabilities macroeconomic conditions are also very important when assessing default probabilities over time

a comparative analysis of current credit risk models the new bis 1998 capital requirements for market risks allows banks to use internal models to assess regulatory capital related to both general market risk and credit risk for their trading book this paper reviews the current proposed industry sponsored credit value at risk methodologies first the credit migration approach as proposed by jp morgan with creditmetrics is based on the probability of moving from one credit quality to another including default within a given time horizon second the option pricing or structural approach as initiated by kmv and which is based on the asset value model originally proposed by merton merton r 1974 journal of finance 28 449 470 in this model the default process is endogenous and relates to the capital structure of the firm default occurs when the value of the firm s assets falls below some critical level third the actuarial approach as proposed by credit suisse financial products csfp with creditrisk and which only focuses on default default for individual bonds or loans is assumed to follow an exogenous poisson process finally mckinsey proposes creditportfolioview which is a discrete time multi period model where default probabilities are conditional on the macro variables like unemployment the level of interest rates the growth rate in the economy which to a large extent drive the credit cycle in the economy 2000 elsevier science b v all rights reserved

coalition proof trade and the friedman rule in the lagos wright model the lagos wright model a monetary model in which pairwise meetings alternate in time with a centralized meeting has been extensively analyzed but always using particular trading protocols here trading protocols are replaced by two alternative notions of implementability one that allows only individual defections and one that also allows cooperative defections in meetings it is shown that the first best allocation is implementable under the stricter notion without taxation if people are sufficiently patient and if people are free to skip the centralized meeting then lump sum taxation used to pay interest on money does not enlarge the set of implementable allocations

money credit and banking in monetary models where agents are subject to trading shocks there is typically an ex post inefficiency since some agents are holding idle balances while others are cash constrained this problem creates a role for financial intermediaries such as banks who accept nominal deposits and make nominal loans in general financial intermediation improves the allocation the gains in welfare come from the payment of interest on deposits and not from relaxing borrowers liquidity constraints we also demonstrate that when credit rationing occurs increasing the rate of inflation can be welfare improving

bubbles and self enforcing debt we characterize equilibria with endogenous debt constraints for a general equilibrium economy with limited commitment in which the only consequence of default is losing the ability to borrow in future periods first we show that equilibrium debt limits must satisfy a simple condition that allows agents to exactly roll over existing debt period by period second we provide an equivalence result whereby the resulting set of equilibrium allocations with self enforcing private debt is equivalent to the allocations that are sustained with unbacked public debt or rational bubbles in contrast to the classic result by bulow and rogoff 1989a positive levels of debt are sustainable in our environment because the interest rate is sufficiently low to provide repayment incentives

the pricing of deposit insurance in the presence of systematic risk based on the merton 1977 put option framework we develop a deposit insurance pricing model that incorporates asset correlations a measurement for the systematic risk of a bank to account for the risk of joint bank failures estimates from our model suggest that actuarially fair risk based deposit insurance that considers only individual bank failure risk is underpriced leaving insurance providers exposed to net losses our estimates also capture the size premium where big banks are priced with higher deposit insurance than small banks this result is particularly relevant to the current regulatory concerns on big banks that are too big to fail above all our approach provides a unifying framework for integrating risk based deposit insurance with risk based basel capital requirements

liquidity constrained markets versus debt constrained markets this paper compares two different models in a common environment the first model has liquidity constraints in that consumers save a single asset that they cannot sell short the second model has debt constraints in that consumers cannot borrow so much that they would want to default but is otherwise a standard complete markets model both models share the features that individuals are unable to completely insure against idiosyncratic shocks and that interest rates are lower than subjective discount rates in a stochastic environment the two models have quite different dynamic properties with the debt constrained model exhibiting simple stochastic steady states while the liquidity constrained model has greater persistence of shocks

a divisible search model of fiat money this paper extends the kiyotaki wright search model of fiat money to allow for divisible money and goods the extension allows me to examine the standard issues in monetary economics such as the neutrality and superneutrality of money by severing the artificial link in the kiyotaki wright model between the money supply and the number of money holders it is shown that money is neutral but not superneutral money growth generates a trading opportunity effect it changes the fraction of different agents in the economy and hence changes the probability with which agents have a successful match in addition money growth has a negative effect on the real money balance that is familiar in walrasian monetary models the balance of the two effects can imply a positive optimal money growth rate

asset prices and liquidity in an exchange economy i develop an asset pricing model in which financial assets are valued for their liquidity the extent to which they are useful in facilitating exchange as well as for being claims to streams of consumption goods the implications for average asset returns the equity premium puzzle and the risk free rate puzzle are explored in a version of the model that nests the work of mehra and prescott 1985

a model of money and credit with application to the credit card debt puzzle many individuals simultaneously have significant credit card debt and money in the bank the credit card debt puzzle is given high interest rates on credit cards and low rates on bank accounts why not pay down the debt while economists have gone to elaborate lengths to explain this observation we argue it is a special case of the rate of return dominance puzzle from monetary economics we analyze the issue by extending standard monetary theory to incorporate consumer debt this seems interesting in its own right since developing models where money and credit coexist is a long standing challenge and it helps put into context recent discussions of consumer debt

collateral secured loans in a monetary economy abstract this paper presents a microfounded model of money where durable assets serve as a guarantee to repay consumption loans we study a steady state equilibrium where money and credit coexist in such an equilibrium a larger investment in durable capital relaxes the borrowing constraint faced by consumers we show that the occurrence of over investment and the behavior of capital accumulation depend on the rate of inflation the relative risk aversion of agents and the marginal productivity of the capital goods

some results on the optimality and implementation of the friedman rule in the search theory of money abstract i characterize a large family of monetary policies that implement milton friedman s prescription of zero nominal interest rates in a monetary search economy with multiple assets and aggregate uncertainty this family of optimal policies is defined by two properties i the money supply must be arbitrarily close to zero for an infinite number of dates and ii asymptotically on average over the dates when fiat money plays an essential role the growth rate of the money supply must be at least as large as the rate of time preference

the challenge of monetary theory departing from custom i want to address a problem that needs to be solved rather than one that has been solved i do not have much to contribute to its solution but i believe that the problem is important and want to focus attention on it in general terms the problem is to find appropriate conceptual foundations for monetary economics i believe that we do not as yet have a suitable theoretical framework for studying the functioning of a monetary system the main obstacle to the development of such a framework is our habit of thinking in terms of frictionless organized i e walrasian markets the problem is partly a problem of language the central concepts of economics demand supply and price are concepts that presuppose a system of centralized walrasian markets we are used to thinking in terms of these concepts and we tend to apply them rather automatically to the market for money frequently without realizing that the market for money must be a rather non walrasian market if indeed it can be called a market at all more or less all the models of monetary economics that are being used in practice proceed in this way using artifical adaptations of the walrasian centralized markets model to accommodate money without actually giving an account of what the role of money in the economy is the problem is one of pure economic theory however it bears on many important questions of applied economics and economic policy to study the relation between money income and prices we need a framework which gives a satisfactory account of the relation between the monetary system and the price mechanism to study the effects of central bank open market

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

nominal bonds and interest rates in this article i integrate the microfoundation of monetary theory with the model of limited participation to analyze the competition between nominal bonds and money the market for government nominal bonds is centralized and walrasian whereas the goods market is modeled as random matches the government imposes a legal restriction that requires all government goods to be purchased with money but not with bonds by contrast private agents can exchange between themselves with both money and bonds i show that an arbitrarily small legal restriction is sufficient to prevent matured bonds from being a medium of exchange i also analyze the effects of monetary policy with and without the legal restriction some of those effects differ significantly from traditional monetary models

the cyclical effects of the basel ii capital requirements abstract capital requirements play a key role in the supervision and regulation of banks the basel committee on banking supervision is in the process of changing the current framework by introducing risk sensitive capital charges some fear that this will unduly increase the volatility of regulatory capital furthermore by limiting the banks ability to lend capital requirements may exacerbate an economic downturn the paper examines the problem of capital induced lending cycles and their pro cyclical effect on the macroeconomy in greater detail it finds that the capital buffer that banks hold on top of the required minimum capital plays a crucial role in mitigating the impact of the volatility of capital requirements

money and dynamic credit arrangements with private information abstract we construct a model with private information in which consumers write dynamic contracts with financial intermediaries a role for money arises due to random limited participation of consumers in the financial market without defection constraints a friedman rule is optimal the mean and variability of wealth tend to fall with inflation in the steady state and the welfare effects of inflation are very small with defection constraints the effects of inflation on the distribution of welfare and consumption are large but the effect on average welfare is still small the relaxation of defection constraints resulting from higher inflation can cause a substantial increase in the real interest rate journal of economic literature classification numbers d8 e4 g2

asset correlations in single factor credit risk models an empirical investigation abstractthe internal ratings based irb approach based on a single risk factor model was designed by the basel committee on banking supervision bcbs to determine banks regulatory credit risk capital key inputs of the model asset correlations are prescribed by the regulator relevant banks must use them for capital determination to ascertain whether these correlations are too onerous or too lenient empirical asset correlations embedded in loss data spanning different loss milieu were backed out of the regulatory model static and rolling correlations over a period of time were compared with the prescribed correlations for developed and developing economies and found to be significantly more conservative

optimal monetary policy in an economy with incomplete markets and idiosyncratic risk abstract this study investigates an incomplete markets economy in which the saving behavior of a continuum of infinitely lived agents is influenced by precautionary saving motives and borrowing constraints agents can use two types of assets interest bearing ious and money to smooth consumption money is valued because of a timing friction in the bond market in particular the bond market closes before agents observe their idiosyncratic productivity shock i find that the friedman rule is not optimal for this economy the results indicate that the optimal allocation has a rate of inflation of 10 and a positive amount of private credit held by the government a positive inflation rate transfers resources from agents with big endowments to those holding bonds which improves risk sharing and therefore welfare however for higher rates of inflation agents economize on money holdings offsetting the insurance effects and causing a reduction in welfare furthermore higher rates of inflation discourage agents from borrowing and the endogenous lower bound on bond holdings is higher than the exogenous borrowing limit high rates of inflation therefore exacerbate frictions in the bond market

asymmetric effects of the business cycle on bank credit risk abstract prior empirical research on the relation between credit risk and the business cycle has failed to properly investigate the presence of asymmetric effects to fill this gap we examine this relation both at the aggregate and the bank level exploiting a unique dataset on italian banks borrowers default rates we employ threshold regression models that allow to endogenously establish different regimes identified by the thresholds over below which credit risk is more less cyclical we find that not only are the effects of the business cycle on credit risk more pronounced during downturns but cyclicality is also higher for those banks with riskier portfolios

budget constraints and demand reduction in simultaneous ascending bid auctions the possibility even if arbitrarily small of binding budget constraints in simultaneous ascending bid auctions induces strategic demand reduction and generates significant inefficiencies under mild conditions on the distributions of the bidders values unconstrained bidders behave as if they were liquidity constrained even as the probability that bidders are budget constrained goes to zero

currency and credit are equivalent mechanisms i study a pure exchange economy with many agents whose marginal utility of consumption is stochastically heterogeneous and independent of wealth with realized marginal utility of wealth private information i show that currency and credit are equivalent to a contract that is efficient when the privacy of information is viewed as a constraint and that the cash in advance constraint is an expression of an incentive constraint

recovery rates default probabilities and the credit cycle in recessions the number of defaulting firms rises on top of this the average amount recovered on the bonds of defaulting firms tends to decrease this paper proposes an econometric model in which this joint time variation in default rates and recovery rate distributions is driven by an unobserved markov chain which we interpret as the credit cycle this model is shown to fit better than models in which this joint time variation is driven by observed macroeconomic variables we use the model to quantitatively assess the importance of allowing for systematic time variation in recovery rates which is often ignored in risk management and pricing models

essential interest bearing money i examine optimal monetary policy in a lagos and wright a unified framework for monetary theory and policy analysis j polit econ 113 2005 463 484 model where trade is centralized and all exchange is voluntary i identify a class of incentivefeasible policies that improve welfare beyond what is achievable with zero intervention any policy in this class necessarily entails a non negative inflation rate and a strictly positive nominal interest rate despite the absence of a lump sum tax instrument there exists an incentive feasible policy that implements the first best allocation

outside versus inside bonds a modigliani miller type result for liquidity constrained economies when agents are liquidity constrained two options exist sell assets or borrow we compare the allocations arising in two economies in one agents can sell government outside bonds and in the other they can borrow by issuing inside bonds all transactions are voluntary implying no taxation or forced redemption of private debt we show that any allocation in the economy with inside bonds can be replicated in the economy with outside bonds but that the converse is not true however the optimal policy in each economy makes the allocations equivalent