mimicking portfolios and exact arbitrage pricing we characterize the sets of mimicking positions with returns that can serve in place of factors in an exact k factor arbitrage pricing relation for a set of n assets all of the sets are k dimensional nonsingular linear transformations of each other we interpret three examples of such transformations and discuss empirical considerations we provide conditions under which the mimicking positions can be expressed as portfolios and we characterize the relation between mimicking portfolios and the minimumvariance frontier

the relative valuation of caps and swaptions theory and empirical evidence although traded as distinct products caps and swaptions are linked by noarbitrage relations through the correlation structure of interest rates using a string market model we solve for the correlation matrix implied by swaptions and examine the relative valuation of caps and swaptions we find that swaption prices are generated by four factors and that implied correlations are lower than historical correlations long dated swaptions appear mispriced and there were major pricing distortions during the 1998 hedge fund crisis cap prices periodically deviate significantly from the no arbitrage values implied by the swaptions market the growth in interest rate swaps during the past decade has led to the creation and rapid expansion of markets for two important types of swap related derivatives interest rate caps and swaptions these over the counter derivatives are widely used by many firms to manage their interest rate risk exposure and collectively represent the largest class of fixed income options in the financial markets the international swaps and derivatives association isda estimates that the total notional amount of caps and swaptions outstanding at the end of 1997 was over 4 9 trillion which was more than 300 times the 15 billion notional of all chicago board of trade treasury note and bond futures options combined caps and swaptions are generally traded as separate products in the financial markets and the models used to value caps are typically different from those used to value swaptions furthermore most wall street firms use a piecemeal approach in calibrating their models for caps and swaptions making it difficult to evaluate whether these derivatives are fairly priced

price inertia and market structure empirical evidence from austrian manufacturing 1993 price inertia and market structure empirical evidence from austrian manufacturing applied economics vol 25 no 9 pp 1175 1186

risk and return in an equilibrium apt application of a new test methodology abstract we use an asymptotic principal components technique to estimate the pervasive factors influencing asset returns and to test the restrictions imposed by static and intertemporal equilibrium versions of the arbitrage pricing theory apt on a multivariate regression model the empirical techniques allow for fairly arbitrary time variation in risk premiums we find that the apt provides a better description of the expected returns on assets than the capital asset pricing model capm however some statistically reliable mispricing of assets by the apt remains

nonstationary term premia and cointegration of the term structure this paper proposes a model of the term structure with nonstationary term premia which exhibit a factor structure this explains the common empirical finding of a cointegrating rank smaller than the one predicted by the rational expectations hypothesis of the term structure an application to german interest rate data yields easily interpretable results

idiosyncratic variation of treasury bill yields i document a dramatic increase in the importance of two types of variation in treasury bill yields beginning in the early 1980s the first is idiosyncratic variation in individual short maturity less than three months bill yields the second is a common component in treasury bill yields that is not shared by yields on other instruments such as short maturity privately issued instruments or longer maturity treasury notes and bonds some evidence suggests the first type reflects increased market segmentation these results have important implications for the calibration and testing of no arbitrage term structure models and interpreting tests of the expectations hypothesis united states treasury bill yields play a central role in economists efforts to understand the behavior of financial markets the focus on treasury bills is driven by the belief that bill yields can be viewed as benchmarks from which yields on other debt instruments are derived for example in no arbitrage models of the default free term structure the stochastic properties of the hypothetical instantaneous interest rate determine bond prices researchers often construct and evaluate these models using short maturity bill yields as proxies for instantaneous interest rates similarly bill yields are frequently used to test the expectations hypothesis of the term structure 2 economists standard pricing models for default risky securities also view treasury yields as building blocks in such models yields on default risky securities depend at least in part on the yields of default free securities and the underlying stochastic default process therefore yields on treasury bills have been used in studies of the effects of monetary policy on the business cycle not because bills are intrinsically critical to the economy but because

can affine term structure models help us predict exchange rates the author proposes an arbitrage free model of the joint behaviour of interest and exchange rates whose exchange rate forecasts outperform those produced by a random walk model a vector autoregression on the forward premiums and the rate of depreciation and the standard forward premium regression

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

arbitrage and the expectations hypothesis this paper shows that all traditional forms of the expectations hypothesis can be consistent with the absence of arbitrage if markets are incomplete a key implication is that the validity of the expectations hypothesis is purely an empirical issue the expectations hypothesis cannot be ruled out on a priori theoretical grounds one of the oldest and best known models in finance is the expectations hypothesis of the term structure introduced by fisher 1896 more than a century ago the expectations hypothesis has become a standard framework for explaining how yields of different maturities are related and it provides an important empirical benchmark from a theoretical perspective however the expectations hypothesis is not generally viewed as a viable model of the term structure in particular cox ingersoll and ross 1981 show that the traditional expectations hypothesis is actually a set of mutually exclusive propositions and offer a proof that most forms of the expectations hypothesis admit arbitrage recently mcculloch 1993 and fisher and gilles 1998 present counterexamples to the cox et al proof showing that the traditional forms of the expectations hypothesis can be consistent with the absence of arbitrage they acknowledge however that their counterexamples are somewhat contrived and view them as economically implausible these results leave the impression that the expectations hypothesis is only consistent with the absence of arbitrage in pathological cases of little practical interest in this paper we argue that the expectations hypothesis is much more theoretically defensible than commonly believed an important point often overlooked is that the cox et al 1981 results are developed in an economic setting where bonds are redundant securities in the more realistic case where bond prices display security specific variation and there is mounting evidence of this traditional forms of the expectations hypothesis can hold quite generally without arbitrage only weak conditions guaranteeing the existence of an equivalent martingale measure need be satisfied for the various forms of the expectations hypothesis to hold without arbitrage a key

the economic determinants of the brazilian nominal term structure of interest rates the purpose of this study is to identify the effects of monetary policy and macroeconomic shocks on the dynamics of the brazilian term structure of interest rates we estimate a near var model under the identification scheme proposed by christiano et al 1996 1999 the results resemble those of the us economy monetary policy shocks that flatten the term structure of interest rates we find that monetary policy shocks in brazil explain a significantly larger share of the dynamics of the term structure than in the usa finally we analyse the importance of standard macroeconomic variables e g gdp inflation and measure of country risk to the dynamics of the term structure in brazil

cross border asset holdings and comovements in sovereign bond markets we analyze the importance of different asset holdings for the interdependence of the yield curves in the euro area using a spatial var model we find that the cross border holdings of long term deb

economic determinants of the nominal treasury yield curve abstract macroeconomic shocks account for most of the variability of nominal treasury yields inducing parallel shifts in the level of the yield curve we develop a new approach to identifying macroeconomic shocks that exploits model based empirical shock measures technology shocks shift yields through their effect on expected inflation and the term premium shocks to preferences for current consumption affect yields through their impact on real rates and expected inflation for both shocks the systematic reaction of monetary policy is an important transmission pathway we find little evidence that fiscal policy shocks are an important source of interest rate variability

the turn of the year in money markets tests of the risk shifting window dressing and preferred habitat hypotheses musto 1997 identifies a turn of the year effect in the commercial paper market and offers risk shifting window dressing as an explanation we revisit this market with different methods and find strong evidence rejecting the risk shifting hypothesis we extend our analysis to other private issue money market instruments and find similar results we find further corroborating evidence in the 1 month t bill market and aggregate demand deposit data our results are consistent with a year end preferred habitat for liquidity associated with year end cash flow obligations

new keynesian macroeconomics and the term structure this article complements the structural new keynesian macro framework with a no arbitrage affine term structure model whereas our methodology is general we focus on an extended macro model with an unobservable time varying inflation target and the natural rate of output which are filtered from macro and term structure data we obtain large and significant estimates of the phillips curve and real interest rate response parameters our model also delivers strong contemporaneous responses of the entire term structure to various macroeconomic shocks the inflation target dominates the variation in the level factor whereas the monetary policy shocks dominate the variation in the slope and curvature factors

is the forward bias economically small evidence from european rates abstract for the purpose of testing uncovered interest parity uip rates of european currencies against the mark offer a distinct advantage the admissible band of the exchange rate mechanism erm induces statistically significant mean reversion in weekly rates thus unlike for freely floating rates there is an expectation signal that has non trivial variation and is sufficiently traceable for research purposes when running the standard regression tests of the unbiased expectations hypothesis at the one week horizon we nevertheless obtain essentially zero coefficients for intra ems exchange rates and the familiar negative coefficients for extra ems rates even more puzzlingly lagged exchange rate changes remain significant when added to the regression a feature that seems hard to explain as a missing variable effect the deviation from uip is significant not just statistically but also economically trading rule tests reveal that for sufficiently large filters the average profit per trade exceeds transaction costs and that cumulative gains can be quite impressive the size of the profits and the patterns from buy versus sell decisions also allow us to reject the hypotheses of either a risk premium or peso issues about realignments as sufficient explanations

the yield curve in a small open economy abstract long term nominal interest rates in a number of inflation targeting small open economies have tended to be strongly correlated with those of the united states this observation has recently led support to the view that in these economies the long end of the yield curve has decoupled from its short end and naturally to a concern that monetary policy may have lost some of its autonomy we set up and estimate a two country small open economy model in which the expectations hypothesis and uncovered interest rate parity hold to study the co movement of long term nominal interest rates of different currencies we show that differences in the persistence of domestic and foreign disturbances a hypothesis for which we find support in recent data can explain the observed pattern of correlations these correlations are not evidence of weaker monetary policy

currency fluctuations in the post bretton woods era the international monetary landscape that has emerged since the felling of bretton woods is characterized by a hybrid exchange rate system that lies somewhere between the textbook polar cases of a gold standard and a pure float this system has relatively flexible exchange rates between major countries active central bank intervention in the market for the major currencies and predominantly fixed exchange rates relative to the dollar or to some basket of currencies for less developed countries and newly industrializing nations the majority of research on currency markets since the early 1970s has focused on the characteristics of flexible exchange rates under this hybrid regime my thesis is that this research has been unsuccessful the proportion of monthly or quarterly exchange rate changes that current models can explain is essentially zero even after the fact forecasts that use actual values instead of forecasted values of the explanatory variables cannot explain major currency movements over the post bretton woods era this result is quite surprising since exchange rate changes would be entirely unpredictable only in very special cases of the theoretical models discussed as the discussion below will argue it is not a general implication of market efficiency that exchange rates follow a random walk process 1

replicating options with positions in stock and cash in most situations of practical relevance the price behavior of a call option is very similar to a combined position involving the underlying stock and borrowing the call price and the stock price will change in the same direction the effect on the call price of a one dollar change in the stock price however will depend on the current price of the stock the number of shares of stock in the replicating portfolio must equal the slope of the call price curve at that price when the call is deep out of the money i e when the stock price is much lower than the striking price a one dollar change in the stock price has little effect on the call price when the stock price is equal to the striking price a one dollar change in the stock price produces roughly a half dollar change in the call price if the stock price rises until the call is deep in the money a one dollar move in the stock price results in nearly a one dollar move in the call price because the call price behaves this way we must revise

news shocks and the slope of the term structure of interest rates abstract we adopt a statistical approach to identify the shocks that explain most of the fluctuations of the slope of the term structure of interest rates we find that one shock can explain the majority of unpredictable movements in the slope impulse response functions lead us to interpret this shock as news about future total factor productivity tfp by showing that slope shocks are essentially tfp news shocks we provide a new explanation for the relationship between the slope and macroeconomic fundamentals our results also provide a new empirical benchmark for structural models at the intersection of macroeconomics and finance jel e23 e43 e52 g12 g14

are optimal search rules reasonable and vice versa and does it matter anyway abstract the economics of search has made rapid progress in recent years and its results have contributed siginificantly to economic knowledge recent work has been particularly marked for the steadily increasing realism of the assumptions describing the environment surrounding the searcher however concomitant with this improvement has been a steady growth in the technical complexity of the problem supposedly solved by the searcher indeed many of the recent models are so complicated that their solutions are beyond the capacity of even modern day computers after elaborating on this impracticability of optimal search rules the paper goes on to consider two more realistic and practical alternatives the adoption of either suboptimal or reasonable rules paradoxically reasonable rules may in some circumstances be better than optimal rules the paper contains a preliminary discussion of what might be meant by reasonable behaviour and shows that a minimal set of criteria for reasonableness leads to the major qualitative conclusions at a market level of optimal search theory

macroeconomic sources of risk in the term structure we develop a new way of modeling time variation in term premia based on the stochastic discount factor model of asset pricing the joint distribution of excess u s bond returns of different maturity and the observable fundamental macroeconomic factors is modeled using multivariate garch with conditional covariances in the mean to capture the term premia by testing the assumption of no arbitrage we derive a specification test of our model we estimate the contribution made to the term premia at different maturities through real and nominal sources of risk from the estimated term premia we recover the term structure of interest rates and examine how it varies through time finally we examine whether the reported failures of the rational expectations hypothesis can be attributed to an omitted time varying term premium

using proxies for the short rate when are three months like an instant the dynamics of the unobservable short rate are frequently estimated directly using a proxy we examine the biases resulting from this practice the proxy problem analytic results show that the proxy problem is not economically significant for single factor affine models in the two factor affine model of longstaff and schwartz 1992 the proxy problem is only economically significant for pricing discount bonds with maturities of more than five years we also describe two different numerical procedures for assessing the magnitude of the proxy problem in a general interest rate model when applied to a nonlinear single factor model they suggest that the proxy problem can be economically significant article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

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

what stopped the inflation unemployment or commodity prices the main object of this paper is to argue that most of the deceleration of inflation in the oecd countries in general including britain that took place between i980 and i982 should be attributed not to the direct impact of higher unemployment on the labour market but to the fall in commodity i e primary product prices from i980 to i982 following their very sharp rise accompanying the second oil shock between i978 and i980 this led to a dramatic turn round of about 50 60 in the prices of primary products imported into the oecd countries from the rest of the world and from other oecd countries which in turn can account for the deceleration of about 20 25 in the import prices for the average industrialised country and our econometric estimates show that the pace of wage inflation is closely correlated with import prices by contrast our estimates for a variety of model specifications and choice of data do not show statistically significant correlations between aggregate unemployment and wage inflation we have not attempted to establish statistically that the turn round in commodity prices was caused mainly by the strength and duration of the posti979 recession in the industrialised countries as a whole but like most commentators we assume that this is the case given this assumption therefore our results imply that the recession in the industrialised world did not as is widely believed slow down the inflation by acting directly on the labour market e g by crushing the unions or bringing a new breath of realism into wage negotiations instead it worked by inducing a collapse of commodity prices or in the case of oil inducing a slight fall by comparison with the preceding sharp rise insofar as our results are valid there are various obvious implications for some central topical economic debates first if there is no stable direct relationship between unemployment within any country and its own rate of wage inflation then there would be no nairu and no clearly identifiable phillips curve as some other investigators have found hence debates as to whether and how far individual economies have unemployment rates above or below their nairus and so on are irrelevant in the conclusions we summarise what seem to be the main policy implications for individual countries but secondly insofar as levels of demand in the industrialised countries taken as a whole influence commodity prices which feed back on wage inflation via

market structure and cyclical fluctuations in u s manufacturing the relevance of imperfect competition for models of economic fluctuations has received increased attention from researchers in both macroeconomics and industrial organization the authors outline a new methodology for estimating industry markups of price over marginal cost and the influence of market structure on cyclical movements in total factor productivity measures of industry concentration import competition and unionization are important for explaining markups in some industry groups much of the estimated markup of price over marginal cost is accounted for by noncapital fixed costs finally the authors show that their estimated margins fluctuate substantially over the cycle in particular markups are countercyclical especially in concentrated durable goods industries copyright 1988 by mit press

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

government bond returns measurement of interest rate risk and the arbitrage pricing theory empirical tests are reported for ross arbitrage pricing theory using monthly data for u s treasury securities during the 1960 1979 period we find that mean returns on bond portfolios are linearly related to at least two factor loadings multivariate test results however are not consistent with the apt our sample data in the u s treasury securities market are also not consistent with either version of the capm one monthahead forecasts of excess returns using factor generating models are compared with corresponding naive predictions or predictions using the market model with various

pricing foreign currency options under stochastic interest rates abstract in this paper we build a general framework to price contingent claims on foreign currencies using the heath et al 1987 model of the term structure closed form solutions are obtained for european options on currencies and currency futures assuming that the volatility functions determining the term structure are deterministic as such this paper provides an example of a bond price process for both the domestic and foreign economies consistent with grabbe s 1983 formulation of the same problem

why do term structures in different currencies co move abstract yield curve fluctuations across different currencies are highly correlated this paper investigates this phenomenon by exploring the channels through which macroeconomic shocks are transmitted across borders macroeconomic shocks affect current and expected future short term rates as central banks react to changing economic environments investors could also respond to these shocks by altering their required compensation for risk macroeconomic shocks thus influence bond yields both through a policy channel and through a risk compensation channel using data from the us the uk and germany we find that world inflation and us yield level together explain over two thirds of the covariance of yields at all maturities further these effects operate largely through the risk compensation channel for long term bonds

optimal price adjustment under imperfect information abstract variations in cost and demand do not have symmetrical impact on the optimal price of the imperfectly competitive firm this asymmetry is not so important as long as information regarding both cost and demand is sufficient however it becomes crucially important in case of incomplete information usually firms have more complete or harder information on cost than on demand this difference in information status on the cost and on the demand side can explain both cost based pricing and slow price adjustment to demand in an optimizing framework with bayesian learning about changed demand conditions

equilibrium valuation of foreign exchange claims this article studies the equilibrium valuation of foreign exchange contingent claims within a continuous time lucas 1982 two country model exchange rates interest rates and in particular factor risk prices are all endogenously and jointly determined this guarantees the internal consistency of these price processes with a general equilibrium in the same model closed form valuation formulas are presented for currency options and currency futures options common to these formulas is that stochastic volatility and stochastic interest rates are admitted hedge ratios and other comparative statics are also provided analytically it is shown that most existing currency option models are included as special cases this article studies the equilibrium valuation and hedging of foreign exchange contingent claims the framework for analysis is the continuous time counterpart of the well known two country monetary model of lucas 1982 1 that is we use the modeling structure of lucas 1982 and adopt his representativeagent perfect pooling equilibrium notion rather than extending the lucas setup to a cox ingersoll and ross 1985a henceforth cir production economy as is done in nielsen and saa requejo 1993 for our purpose the lucas framework offers the desired simplicity and tractability we assume a stochastic structure for the international economy such that the resulting nominal interest rates and exchange rate dynamics exhibit similar empirically plausible features as the corresponding ones in nielsen and saa requejo 1993 for example the endogenous interest rates are positively correlated across national borders campbell and clarida 1987 and ilmanen 1995 as a predictor of future spot exchange rates the equilibrium forward exchange rate is biased in a direction consistent with the forward premium puzzle

macro factors and the term structure of interest rates this paper presents an essentially affine model of the term structure of interest rates making use of macroeconomic factors and their long run expectations the model extends the approach pioneered by kozicki and tinsley 2001 by modeling consistently long run inflation expectations simultaneously with the term structure application to the u s economy shows the importance of long run inflation expectations in the modeling of long term bond yields the paper also provides a macroeconomic interpretation for the latent factors found in standard finance models of the yield curve the level factor represents the long run inflation expectation of agents the slope factor captures business cycle conditions and the curvature factor expresses a clear independent monetary policy factor

stylized facts on nominal term structure and business cycles an empirical var study this paper examines the importance of various macroeconomic shocks in explaining the movement of the term structure of nominal bond yields in the post war usa as well as the channels through which such macro shocks influence the yield curve using a structural vector autoregressive var model the results show that the monetary policy and the aggregate supply shocks are important determinants of the nominal term structure moreover the monetary policy innovations have a large but transitory effect on the nominal bond yields primarily by changing the slope of the yield curve and the aggregate supply shocks from private sector have a more persistent effect on the level of the yield curve but have little effect on the slope of the yield curve

a new measure of cross sectional risk and its empirical implications for portfolio risk management abstract litterman et al litterman r scheinkman j weiss l 1991 volatility and the yield curve journal of fixed income 1 june 49 53 and engle and ng engle r f ng v k 1993 time varying volatility and the dynamic behavior of the term structure journal of money credit and banking 25 3 336 349 provide empirical evidence of a relation between yield curve shape and volatility this study offers theoretical support for that finding in the general context of cross sectional time series we introduce a new risk measure quantifying the link between cross sectional shape and market risk a simple econometric procedure allows us to represent the risk experienced by cross sections over a time period in terms of independent factors reproducing possible cross sectional deformations we compare our risk measure to the traditional cross yield covariance according to their relative performance empirical investigation in the us interest rate market shows that 1 cross shape risk factors outperform cross yield risk factors i e yield curve level slope and convexity in explaining the market risk of yield curve dynamics 2 hedging multiple liabilities against cross shape risk delivers superior trading strategies compared to those stemming from cross yield risk management

macroeconomic models and the yield curve an assessment of the fit abstract many have questioned the empirical relevance of the calvo yun model this paper adds a term structure to three widely studied macroeconomic models calvo yun hybrid and svensson we back out from observations on the yield curve the underlying macroeconomic model that most closely matches the level slope and curvature of the yield curve with each model we trace the response of the yield curve to macroeconomic shocks we assess the fit of each model against the observed behaviour of interest rates and find limited support for the calvo yun model in terms of fit with the observed yield curve we find some support for the hybrid model but the svensson model performs best

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

the relation between price and marginal cost in u s industry an examination of data on output and labor input reveals that some u s industries have marginal cost well below price the conclusion rests on the finding that cyclical variations in labor input are small compared with variations in output in booms firms produce substantially more output and sell it for a price that exceeds the costs of the added inputs the paper documents the disparity between price and marginal cost where marginal cost is estimated from annual variations in cost it considers a variety of explanations of the findings that are consistent with competition but none is found to be completely plausible

applying a macro finance yield curve to uk quantitative easing we estimate a macro finance yield curve model for both the nominal and real forward curve for the uk from 1993 to 2008 our model is able to accommodate a number of key macroeconomic variables and allows us to estimate the instantaneous response of the yield curve and so gauge the impact of quantitative easing on forward rates we find that 10 year nominal interest rates on average are lower by 46 basis points which can largely be explained by three main channels portfolio balance liquidity premium and signalling but there is no sizeable impact on real interest rates

international house price cycles monetary policy and credit abstract we evaluate three alternative predictors of house price corrections anticipated tightenings of monetary policy deviations of house prices from fundamentals and rapid credit growth a new cross country measure of monetary policy expectations based on an international term structure model with time varying risk premiums is constructed house price overvaluation is estimated via an asset pricing model the variables are incorporated into a panel logit regression model that estimates the likelihood of a large house price correction in 18 oecd countries the results show that corrections are predicted by increases in the market s forecast of higher policy rates the estimated degree of house price overvaluation also contains significant information about subsequent price reversals in contrast to the financial crisis literature credit growth is less important all of these variables help forecast recessions

determinants of price adjustment this paper reports results of an empirical study investigating the adjustment speed of prices to change in costs and demand particular emphasis is laid on the impact of concentration on the adjustment speed in addition the effects of the business cycle and capital intensity are considered it shows that concentrated industries tend to adjust prices faster while capital intensity has a negative impact prices are more flexible during an upswing than in times of a recession

macro factors and the affine term structure of interest rates this paper formulates an affine term structure model of bond yields from a dynamic stochastic general equilibrium model with observable macro state variables as the term structure factors model implications for the joint macro term structure dynamics are consistent with the empirical patterns from the var estimation model calibration and simulation exercises also provide clear macroeconomic interpretations of the latent term structure factors as found in the finance literature most of the slope factor movement can be explained by exogenous monetary policy shocks and the level factor movement is closely related to the technology shocks

a new choice of dynamic asset management the variable proportion portfolio insurance the constant proportion portfolio insurance cppi achieves the advantage of simplicity due to its constant multiple however a dynamic multiple could improve the effectiveness of portfolio management in this article we provide a complete and detailed examination of the mechanism of variable proportion portfolio insurance vppi strategy the multiple of the vppi states that when the stock price goes up the multiple gets larger accordingly and when the stock price goes down the multiple gets smaller a portfolio insurance strategy with this discipline could yield better performance based on this principle we recommend an exponential proportion portfolio insurance eppi in addition we also propose a new performance measure for portfolio insurance compared with the cppi simulation and empirical evidence support that the eppi works better in both upside capture and downside protection implying that the eppi could be an effective tool for asset management

canonical term structure models with observable factors and the dynamics of bond risk premia we derive a canonical representation for the no arbitrage discrete time term structure models with both observable and unobservable state variables popularized by ang and piazzesi 2003 we conduct a specification analysis based on this canonical representation and we analyze how alternative parameterizations affect estimated risk premia impulse response functions and variance decompositions we find a trade off between the need to obtain parsimonious parameterizations and the ability of the models to match observed patterns of variation in risk premia we also find that more richly parameterized models uncover a greater influence of macroeconomic fundamentals on the long end of the yield curve

hot hands in bond funds we investigate persistence in the relative performance of 3549 bond mutual funds from 1990 to 2003 we show that bond funds that display strong weak performance over a past period continue to do so in future periods the out of sample difference in risk adjusted return between the top and bottom decile of funds ranked on past alpha exceeds 3 5 percent per year we demonstrate that a strategy based on past fund returns earns an economically and statistically significant abnormal return suggesting that bond fund investors can exploit the observed persistence our results are robust to a wide range of model specifications and bootstrapped test statistics

common factors in international bond returns in this paper we estimate and interpret the factors that jointly determine bond returns of different maturities in the us germany and japan we analyze both currency hedged and unhedged bond returns for currency hedged bond returns we find that five factors explain 96 5 of the variation of bond returns these factors can be associated with changes in the level and steepness of the term structures in some of these countries in particular it turns out that changes in the level of the term structures are correlated across countries while changes in the steepness of the term structures are country specific the five factor model also provides a good fit of the expected returns of bond returns in all countries we find similar results for bond returns that are not hedged for currency risk finally we show how the model can be used to calculate the value at risk for international bond portfolios and to price cross currency interest rate derivatives and compare the results with simpler models

exchange rates and interest rates can term structure models explain currency movements abstract we construct an international term structure model that has excellent empirical performance in tracking movements of exchange rates and currency returns the forward premium puzzle is accounted for yet the model does not have the undesirable properties found in backus et al j finance 56 2001 279 examination of the estimated factor structure indicates that local factors are not important in the us uk and german markets moreover we find that term structure factors alone cannot satisfactorily explain exchange rate movements in other words exchange rates are also affected by other factors that are not in the interest rate dynamics

portfolio insurance and prospect theory investors popularity and optimal design of capital protected financial products abstract portfolio insurance strategies are used on both the institutional and the retail side of the asset management industry while standard utility theory struggles to provide an explanation this study justifies the popularity of portfolio insurance strategies in a behavioral finance context we run monte carlo simulations as well as historical simulations for popular portfolio insurance strategies and benchmark strategies in order to evaluate the outcomes using cumulative prospect theory our simulation results indicate that most portfolio insurance strategies are the preferred investment strategy for a prospect theory investor moreover the analysis provides insights into how portfolio insurance products should be designed and structured to meet the preferences of prospect theory investors as accurately as possible

shape factors and cross sectional risk abstract galluccio and roncoroni 2006 empirically demonstrate that cross sectional data provide relevant information when assessing dynamic risk in fixed income markets we put forward a theoretical framework supporting that finding based on the notion of shape factors we devise an econometric procedure to identify shape factors propose a dynamic model for the yield curve develop a corresponding arbitrage pricing theory derive interest rate pricing formulae and study the analytical properties exhibited by a finite factor restriction of rate dynamics that is cross sectionally consistent with a family of exponentially weighed polynomials we also conduct an empirical analysis of cross sectional risk affecting us swap euro bond and oil markets results support the conclusion whereby shape factors outperform the classical yield resp price factors i e level slope and convexity in explaining the underlying fixed income resp commodity market risk the methodology can in principle be used for understanding the intertemporal dynamics of any cross sectional data

estimating and forecasting the yield curve using a markov switching dynamic nelson and siegel model we estimate versions of the nelson siegel model of the yield curve of u s government bonds using a markov switching latent variable model that allows for discrete changes in the stochastic process followed by the interest rates our modeling approach is motivated by evidence suggesting the existence of breaks in the behavior of the u s yield curve that depend for example on whether the economy is in a recession or a boom or on the stance of monetary policy our model is parsimonious relatively easy to estimate and exible enough to match the changing shapes of the yield curve over time we also derive the discrete time non arbitrage restrictions for the markov switching model we compare the forecasting performance of these models with that of the standard dynamic nelson and siegel model and an extension that allows the decay rate parameter to be time varying we show that some parameterizations of our model with regime shifts outperform the single regime nelson and siegel model and other standard empirical models of the yield curve

factor models and the correlation structure of interest rates some evidence for usd gbp dem and jpy abstract the aim of this paper is to develop models for producing accurate forecasts for the correlation of spot and forward interest rates correlation forecasts generated from factor models where the correlations are expressed as a function of few underlying factors are compared to forecasts produced by less sophisticated models like the full historical and constant correlation model contrary to previous studies where the selection of factors is rather arbitrary we test two factor identification methodologies the first is based on factor analysis and the second is based on minimising the residual cross correlations we show that a three factor model with factors identified by minimising the residual cross correlation criterion is sufficient to describe the correlation structure of interest rates furthermore we show that it might be preferable to assume that all forward rate correlations are equal rather than using a misspecified factor model and that the spot factor model developed consistently outperformed long established models like the barbell model

yield factor volatility models the term structure of interest rates is often summarized using a handful of yield factors that capture shifts in the shape of the yield curve in this paper we develop a comprehensive model for volatility dynamics in the level slope and curvature of the yield curve that simultaneously includes level and garch effects along with regime shifts we show that the level of the short rate is useful in modeling the volatility of the three yield factors and that there are significant garch effects present even after including a level effect further we find that allowing for regime shifts in the factor volatilities dramatically improves the model s fit and strengthens the level effect we also show that a regime switching model with level and garch effects provides the best out of sample forecasting performance of yield volatility we argue that the auxiliary models often used to estimate term structure models with simulation based estimation techniques should be consistent with the main features of the yield curve that are identified by our model

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

inventories and sticky prices more on the microfoundations of macroeconomics the role of inventories in making prices sticky is studied by analyzing a dynamic linear quadratic model of a monopoly firm facing stochastic demand but able to store its finished goods in inventory it is shown that in contrast to the usual presumption firms that exhibit the smallest output responses to demand fluctuations may also exhibit the smallest price fluctuations specifically firms which have very flexible inventory storage facilities or are subjected to very transitory demand shocks will rely on inventories as buffers and will change neither production nor price very much on the other hand firms which have very inflexible storage facilities or whose demand shocks are quite permanent will display large swings in both price and output the standard assumption about inventory carrying costs that has been used in the literature that they are linear is shown to imply that production is impervious to fluctuations in demand it is also established that prices may respond more strongly to positive demand shocks than to negative ones if it is impossible to hold negative inventories i e to have unfilled orders the model offers an explanation for stickiness in relative prices however under certain circumstances it may help explain the persistence of inflation this abstract was borrowed from another version of this item

the effects of volatility misestimation on option replication portfolio insurance to insure a stock portfolio one could purchase a put option with a striking price equal to some desired minimum value for the portfolio alternatively one could replicate this stock plus put portfolio with a portfolio of stock and cash the initial allocations to stock and cash will depend upon the parameters of an option valuation formula and will change as those parameters change in particular the construction of such synthetic optionreplicating portfolio insurance hence its outcome will depend critically on correct estimation of the volatility of the portfolio being insured volatility misestimation will cause the price of the synthetic put to deviate from its expected price and will result in incorrect allocations between stock and cash as a result the outcome of a synthetic portfolio insurance strategy based on misestimated volatility will be unpredictable a manager who underestimates volatility will typically end up buying less insurance than is necessary to ensure a given return while a manager who overestimates volatility will buy more insurance than is necessary both outcomes can be costly in terms of missed floors and forgone gains simulations of portfolio insurance performance over the period of the october 1987 market crash indicate that most insured portfolios would have fallen short of their promised values in general however the lower the guaranteed floor of the insurance program hence the lower its insurance the worse its results

a synthetic factor approach to the estimation of value at risk of a portfolio of interest rate swaps in this paper we decompose the interest rate swap yield curves of 10 major currencies into their common factors and find that the first two factors interpreted as parallel shift and rotation explain between 97 1 and 98 6 of the variation in the interest rate swap rates across all 10 currencies the main contribution of the paper however is that we then model these two factors as simplified synthetic factors so that they may be used to develop an innovative approach to the computation of value at risk var for a portfolio of interest rate swaps 2000 elsevier science b v all rights reserved

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