currency risk factors in a recursive multicountry economy we study a risk sharing model featuring multiple countries with recursive prefer ences defined over bundles of consumption goods whose supply is subject to both global and local short and long run shocks first we quantify the extent of con tagion and insurance possibilities as we vary the number of countries in the econ omy second we introduce persistent heterogeneous exposure to global long run news shocks and analyze the properties of several carry trade strategies in the context of our model lustig et al 2011 hml fx and della corte et al 2013 hml na the average excess returns of these strategies can be rationalized in a recursive risk sharing scheme with long run global shocks to output growth

asset prices and risk sharing in open economies this paper proposes a two good two country general equilibrium model with external habits and home biased preferences that addresses a number of international nance puzzles speci cally the model reconciles the high degree of international risk sharing implied by relatively smooth exchange rates with the modest cross country consumption growth correlations seen in the data resolving the brandt cochrane and santa clara 2006 puzzle furthermore the model matches the empirically observed low correlation between exchange

uncertainty currency excess returns and risk reversals abstract in this paper we provide strong evidence that heightened uncertainty in the u s real economy or financial markets significantly raises excess returns to the currency carry trade we posit that this works through the influence of uncertainty on global investors risk preferences macro and financial uncertainty also lower foreign exchange risk reversals an effect that is particularly strong for high interest rate portfolios our results are consistent with the idea that an increase in uncertainty regarding the u s economy or financial markets increases investors risk aversion which in turn drives up the expected returns and the cost of protection against crash risk in the fx market

rare disasters and exchange rates we propose a new model of exchange rates which yields a theory of the forward premium puzzle our explanation combines two ingredients the possibility of rare economic disasters and an asset view of the exchange rate our model is frictionless has complete markets and works for an arbitrary number of countries in the model rare worldwide disasters can occur and affect each country s productivity each country s exposure to disaster risk varies over time according to a mean reverting process ri sky countries command high risk premia they feature a depreciated exchange rate and a high interest rate as their risk premium mean reverts their exchange rate appreciates therefore currencies of high interest rate countries appreciate on average to make the notion of disaster risk more implementable we show how options prices might in principle uncover latent disaster risk and help forecast exchange rate movements we then extend the framework to incorporate two factors a disaster risk factor and a business cycle factor we calibrate the model and obtain quantitatively realistic values for the volatility of the exchange rate the forward premium puzzle regression coefficients and near random walk exchange rate dynamics finally we solve a model of stock markets across countries which yields a series of predictions about the joint behavior of exchange rates bonds options and stocks across countries the evidence from the options market appears to be supportive of the model jel e43 e44 f31 g12 g15

money interest rates and exchange rates with endogenously segmented markets we analyze the effects of money injections on interest rates and exchange rates when agents must pay a baumol tobin style fixed cost to exchange bonds and money asset markets are endogenously segmented because this fixed cost leads agents to trade bonds and money infrequently when the government injects money through an open market operation only those agents that are currently trading absorb these injections through their impact on these agents consumption these money injections affect real interest rates and real exchange rates the model generates the observed negative relation between expected inflation and real interest rates as well as persistent liquidity effects in interest rates and volatile and persistent exchange rates

seasonality and habit persistence in a life cycle model of consumption summary the allocation of non durable consumers expenditure over the four quarters of the year reflects choices made by consumers implying a utility function exhibiting seasonality incorporating such a function the life cycle model fails to explain fully the observed dynamics in uk seasonally unadjusted data seasonal habit persistence effects are introduced and found to be significant although this generalized model stands up well to testing in a univariate context it fails to exclude a predictive role for lagged income changes seasonality is inherent in many economic time series but it is rarely considered to be an issue of interest in econometric model building rather than explicitly investigating the economics underlying seasonal variation modellers typically try to remove its effects either by using seasonally adjusted data or by including seasonal intercept dummies in their equations the former practice is criticized by wallis 1974 who shows that it may distort the relationship between variab le the latter assumes that the function simply shifts up or down with the season however except for degrees of freedom considerations there seems to be no a priori reason why the same parameters or functional form should apply at different times of the year indeed gersovitz and mackinnon 1978 argue that realistic utility cost or production functions result in models in which seasonal influences cannot be separated out in a simple fashion in the present study seasonality is treated as one of the features to be explained within the economic model thus in the particular application to non durable consumers expenditure it is argued that the allocation of expenditure over the year reflects seasonal tastes and hence seasonality in the underlying utility function the implications of this are explicitly investigated the framework for our analysis is the influential paper by hall 1978 who derives a randomwalk model for real non durable consumers expenditure when rational expectations are combined with a life cycle theory of consumption hall does not investigate seasonality at all and employs seasonally adjusted values in his empirical analysis although subsequent us authors have examined many aspects of this theory the type of data used has rarely been

interest rates and currency prices in a two country world abstract this paper is a theoretical study of the determination of prices interest rates and currency exchange rates set in an infinitely lived two country world which is subject both to stochastic endowment shocks and to monetary instability formulas are obtained for pricing all equity claims nominally denominated bonds and currencies and these formulas are related to earlier closely related results in the theories of money finance international trade

time varying international diversification and the forward premium abstract this paper reproduces the slope of the uncovered interest rate parity uip regression for ten country pairs within one standard deviation under rational expectations we propose an infinite horizon dynamic stochastic general equilibrium model with incomplete markets heterogeneous investors experience varying risk aversion as a result of habit formation the underlying mechanism of the model relies on varying international diversification in the investors portfolio choice decision in response to their changing habit levels investors hedging desire varies over time this leads to adjustments in interest rates the habit induced investment decisions are negatively correlated with movements in the exchange rate this results in a negative correlation between interest rates and expected exchange rates as implied by a negative uip slope depending on the magnitude of habits the model is capable of reproducing positive as well as negative uip slopes as seen empirically in the data

the impact of jumps on carry trade returns abstract this paper investigates how jump risks are priced in currency markets we find that currencies whose changes are more sensitive to negative market jumps provide significantly higher expected returns the positive risk premium constitutes compensation for the extreme losses during periods of market turmoil using the empirical findings we propose a jump modified carry trade strategy which has approximately two percentage point per annum higher returns than the regular carry trade strategy these findings result from the fact that negative jump betas are significantly related to the riskiness of currencies and business conditions

earmarked taxation welfare versus political support abstract compared with the traditional public finance approach of a monolithic fully informed planner earmarking of taxation is less likely to be optimal if a principal agent setting is considered where taxing and spending are performed by two separate agents which are monitored by the parliament we assume that the parliament either maximizes welfare or expected votes vote maximizers are more inclined to choose earmarking but at the price of inefficiently high costs

international risk cycles abstract recent work in international finance suggests that exchange rate puzzles can be accounted for if 1 aggregate uncertainty is time varying and 2 countries have heterogeneous exposures to a world aggregate shock we embed these features in a standard two country real business cycle framework and calibrate the model to equity risk premia in low and high interest rates countries unlike traditional real business cycle models our model generates volatile exchange rates a large currency forward premium excess comovement of asset prices relative to quantities and an imperfect correlation between relative consumption growth and exchange rates our model implies however that high interest rate countries have smoother quantities equity returns and interest rates than low interest rate countries contrary to the data

forward and spot exchange rates in a multi currency world separate literatures study violations of uncovered interest parity uip using regression based and portfolio based methods we propose a decomposition of these violations into a cross currency a between time and currency and a cross time component that allows us to analytically relate regression based and portfolio based facts and to estimate the joint restrictions they put on models of currency returns subject to standard assumptions on investors information sets we find that the forward premium puzzle fpp and the dollar trade anomaly are intimately linked both are driven almost exclusively by the cross time component by contrast the carry trade anomaly is driven largely by cross sectional violations of uip the simplest model that the data do not reject features a cross sectional asymmetry that makes some currencies pay permanently higher expected returns than others and larger time series variation in expected returns on the u s dollar than on other currencies importantly conventional estimates of the fpp are not directly informative about expected returns because they do not correct for uncertainty about future mean interest rates once we correct for this uncertainty we never reject the null that investors expect high interest rate currencies to depreciate not appreciate

can information heterogeneity explain the exchange rate determination puzzle empirical evidence shows that most exchange rate volatility at short to medium horizons is related to order flow and not to macroeconomic variables we introduce symmetric information dispersion about future macroeconomic fundamentals in a dynamic rational expectations model in order to explain these stylized facts consistent with the evidence the model implies that a observed fundamentals account for little of exchange rate volatility in the short to medium run b over long horizons the exchange rate is closely related to observed fundamentals c exchange rate changes are a weak predictor of future fundamentals and d the exchange rate is closely related to order flow

commodity trade and international risk sharing how much do financial markets matter abstract this paper evaluates the social gains from international risk sharing in some simple general equilibrium models with output uncertainty a simulation model calibrated to selected moments of u s and japanese data estimates the incremental loss from a ban on international portfolio diversification to be on the order of 0 20 percent of output per year even the theoretical gains from asset trade may disappear under alternative sets of assumptions on preferences and technology the paper argues that the small magnitude of potential trade gains may help explain the apparently inconsistent findings of empirical studies on the degree of international capital mobility

uncertainty and deviations from uncovered interest rate parity abstract it is well known that uncovered interest rate parity does not hold empirically especially at short horizons but is it really so we conjecture that uncovered interest rate parity is more likely to hold in low uncertainty environments relative to high uncertainty ones since arbitrage opportunity gains become more uncertain in a highly unpredictable environment thus blurring the relationship between exchange rates and interest rate differentials in this paper we first provide a new exchange rate uncertainty index that measures how unpredictable exchange rates are relative to their historical past then we use the new measure of uncertainty to provide empirical evidence that uncovered interest rate parity does hold in five industrialized countries vis a vis the us dollar at times when uncertainty is not exceptionally high and breaks down during periods of high uncertainty

general fund financing versus earmarked taxes an alternative model of budgetary choice in a democracy this paper presents an alternative model of budgetary choices in a direct democracy our model is not only more consistent with the underlying assumptions of consumer theory but also is easier to apply to the study of problems such as the impact of lump sum subsidies changes in the costs of production and so forth on the equilibrium levels of collective variables

the role of portfolio constraints in the international propagation of shocks we study the comovement among stock prices and exchange rates in a three good three country centre periphery dynamic equilibrium model in which the centre s agents face portfolio constraints we characterize equilibrium in closed form for a broad class of portfolio constraints solving for stock prices terms of trade and portfolio holdings we show that portfolio constraints generate wealth transfers between the periphery countries and the centre which increase the comovement of the stock prices across the periphery we associate this excess comovement caused by portfolio constraints with the phenomenon known as contagion the model generates predictions consistent with other important empirical results such as amplification and flight to quality effects copyright 2008 wiley blackwell

the impact of medicaid on labor market activity and program participation evidence from the oregon health insurance experiment united states dept of health and human services assistant secretary for planning and evaluation

empirical evidence on the currency carry trade 1900 2012 abstract most of the currency literature investigates the risk and return characteristics of the currency carry trade after the collapse of the bretton woods system in order to gauge the long term currency carry premium we extend the sample to 20 currencies over the period 1900 to 2012 we find modest sharpe ratios in the range of 0 2 0 4 for carry trading over this period this is markedly lower than the sharpe ratios above 0 6 reported for recent sample periods we document that carry trading occasionally incurs substantial losses which fits well with risk based explanations for deviations from uncovered interest parity we find that large carry trading losses do not necessarily coincide with large losses in global equity markets our results help to better understand the source and nature of excess returns on the carry trade

time varying rare disaster risks oil returns and volatility abstract this paper provides a novel perspective to the predictive ability of rare disaster risks for west texas intermediate wti oil market returns and volatility using a nonparametric quantile based methodology over the monthly period of 1918 01 2013 12 we show that a nonlinear relationship and structural breaks exists between oil returns and various rare disaster risks hence linear granger causality tests are misspecified and the linear model results of non predictability are unreliable however the quantile causality test shows that rare disaster risks strongly affect both wti returns and volatility with stronger evidence of predictability observed at lower quantiles of the respective conditional distributions our results are robust to alternative specification of volatility based on a garch model and measure of rare disaster risks based on the number of crises

habit formation in consumption and its implications for monetary policy models this paper explores a monetary policy model with habit formation for consumers in which consumers utility depends in part on current consumption relative to past consumption the empirical tests developed in the paper show that one can reject the hypothesis of no habit formation with tremendous condence largely because the habit formation model captures the gradual hump shaped response of real spending to various shocks the paper then embeds the habit consumption specication in a monetary policy model and nds that the responses of both spending and inflation to monetary policy actions are signicantly improved by this modication jel d12 e52 e43

risk external adjustment and capital flows abstract this paper studies the process of external adjustment i develop an open economy model with endowment and preference shocks that can account for the empirical behavior of real exchange rates interest rates and consumption in the u s and europe the model includes cross border holdings of bonds and equity and financial frictions that impede international risk sharing i find that external adjustment following endowment shocks predominantly takes place via trade flows consistent with the intertemporal approach to the current account in contrast preference shocks that change investors risk aversion induce adjustment via the trade and valuation channels where the latter includes the effects of unexpected capital gains and loss on existing cross border holdings and changes in the expected future return differentials between foreign assets and liabilities the model estimates imply that the valuation channel of external adjustment is more important for the u s than the trade channel consistent with this implication i show that forecasts of future return differentials contributed most to the volatility of the u s net foreign asset position in the post bretton woods era

a reexamination of the uncovered interest rate parity hypothesis abstract it is now widely known that the uncovered interest rate parity uip hypothesis which states that forward exchange rates are unbiased predictors of future spot exchange rates is generally rejected by empirical evidence we show in this paper by means of a cox et al 1985 model extended to a two country economy that a careful examination of the no arbitrage principle leads to a different formulation for this hypothesis roughly speaking this new formulation states that the expected future spot exchange rate is equal to the forward exchange rate multiplied by a term premium whose closed form expression can be derived moreover this multiplicative term premium reduces to 1 i e the standard uip hypothesis holds if and only if conditional variances are deterministic in short we show that rejection of the standard uip hypothesis is not surprising as long as arch effects have been evidenced in exchange rate data as a by product we provide a parametric and tractable specification for the so called risk premium i e the component of the expected exchange rate in excess of the forward exchange rate

on the size distribution of macroeconomic disasters confidence interval of 2 to 4 the results are robust to uncertainty about the values of the disaster probability and the equity premium and can accommodate seemingly paradoxical situations in which the equity premium may appear to be infinite

asset prices and exchange rates in this paper we study the implications of introducing demand shocks and trade in goods into an otherwise standard international asset pricing model trade in goods gives rise to an additional channel of international propagation through the terms of trade absent in traditional single good asset pricing models the inclusion of demand shocks helps overturn many unrealistic implications of existing international flnance models in which productivity shocks are the sole source of uncertainty our model generates a rich set of implications on how stock bond and foreign exchange markets co move we solve the model in closed form which yields a system of equations that can be readily estimated empirically our estimation validates the main predictions of the theory

the implications of first order risk aversion for asset market risk premiums abstract in an effort to explain simultaneously the excess return predictability observed in equity bond and foreign exchange markets we incorporate preferences exhibiting first order risk aversion into a general equilibrium two country monetary model when we calibrate the model to us and japanese data we find that first order risk aversion substantially increases excess return predictability however this increased predictability is insufficient to match the data we conclude that the observed patterns of excess return predictability are unlikely to be explained purely by time varying risk premiums generated by highly risk averse agents in a complete markets economy

time varying risk interest rates and exchange rates in general equilibrium under mild assumptions the data indicate that time varying risk is the primary force driving nominal interest rate differentials on currency denominated bonds this finding is an immediate implication of the fact that exchange rates are roughly random walks a general equilibrium monetary model with an endogenous source of risk variation a variable degree of asset market segmentation can produce key features of actual interest rates and exchange rates in this model the endogenous segmentation arises from a fixed cost for agents to exchange money for assets as inflation varies so does the benefit of asset market participation and that changes the fraction of agents participating these effects lead the risk premium to vary systematically with the level of inflation this model produces variation in the risk premium even though the fundamental shocks have constant conditional variances

modernizing federal economic statistics abstract official statistical data on the structure evolution and performance of the u s economy are produced by a variety federal state and local agencies much of the methodology policy frameworks and infrastructure for u s economic measurement have been in place for decades there are growing concerns that the economy is evolving more rapidly than are the economic statistics we use to monitor it we discuss both the challenges and opportunities to modernizing federal economic statistics we describe an incremental approach that federal statistics agencies can follow to build a 21st century economic measurement system

volatile and persistent real exchange rates with or without sticky prices the flexible price two country monetary model is extended to include a consumption externality with habit persistence two methodologies are employed to explore this model s ability to generate volatile and persistent exchange rates in the first actual data is used for the exogenous driving processes in the second the model is simulated using estimated forcing processes the theory in both cases is capable of explaining the high volatility and persistence of real and nominal exchange rates as well as the high correlation between real and nominal rates

can exchange rates forecast commodity prices we show that commodity currency exchange rates have surprisingly robust power in predicting global commodity prices both in sample and out of sample and against a variety of alternative benchmarks this result is of particular interest to policy makers given the lack of deep forward markets in many individual commodities and broad aggregate commodity indices in particular we also explore the reverse relationship commodity prices forecasting exchange rates but find it to be notably less robust we offer a theoretical resolution based on the fact that exchange rates are strongly forward looking whereas commodity price fluctuations are typically more sensitive to short term demand imbalances

do asset demand functions optimize over the mean and variance of real returns a six currency test abstract international asset demands are functions of expected returns optimal portfolio theory tells us that the coefficients in this relationship depend on the variance covariance matrix of real returns but previous estimates of the optimal portfolio 1 assume expected returns constant and 2 are not set up to test the hypothesis of mean variance optimization we use maximum likelihood estimation to impose a constraint between the coefficients and the error variance covariance matrix for a portfolio of six currencies we are able statistically to reject the constraint evidently investors are either not sophisticated enough to maximize a function of the mean and variance of end of period wealth or else are too sophisticated to do so

an examination of uncovered interest rate parity in segmented international commodity markets we examine the effect of segmented commodity markets on the relation between forward and future spot exchange rates in a dynamic economy we calculate the slope coefficient in our theoretical economy from regressing exchange rate changes on forward premia with reasonable parameter values the slope coefficient is less than unity however even for extreme parameters the slope is not less than zero as found in the data a negative slope coefficient in a nominal version of the model requires the covariance between monetary shocks and relative output shocks to be significantly negative in contrast to the covariance in the data one of the most studied relations in international finance is that between forward exchange rates and future spot rates empirical tests typically find that when one regresses changes in spot rates on forward premia the slope coefficient is less than one and often negative this result is called the forward bias anomaly and implies that the returns from investing in forward exchange contracts are predictable our objective is to examine the effect of segmentation of international commodity markets on the relation between the forward premium and the change in the spot rate segmentation of commodity markets is modeled by introducing a cost for transferring goods across countries giving rise to deviations from purchasing power parity ppp in this article we first derive the theoretical implications of the effect of segmentation on the forward bias in a dynamic general equilibrium model and then analyze a calibrated version of the model our analysis serves as a useful benchmark to study how much of the predictable deviations from uncovered interest parity uip can be explained by endogenous deviations from ppp

excess comovements between the euro us dollar and pound sterling us dollar exchange rates abstractthe aim of this article is to discuss excess comovements of the euro us dollar and pound sterling us dollar exchange rates i e we look for comovements of exchange rates which are stronger

anomalies foreign exchange most all behavior can be explained by assuming that agents have stable well defined preferences and make rational choices consistent with those preferences in markets that eventually clear an empirical result qualifies as an anomaly if it is difficult to rationalize or if implausible assumptions are necessary to explain it within the paradigm this column will present a series of such anomalies readers are invited to suggest topics for future columns by sending a note with some reference to or better yet copies of the relevant research comments on anomalies printed here are also welcome the address

optimal consumption and portfolio policies when asset prices follow a diffusion process abstract we consider a consumption portfolio problem in continuous time under uncertainty a martingale technique is employed to characterize optimal consumption portfolio policies when there exist nonnegativity constraints on consumption and on final wealth we also provide a way to compute and verify optimal policies our verification theorem for optimal policies involves a linear partial differential equation unlike the nonlinear partial differential equation of dynamic programming the relationship between our approach and dynamic programming is discussed we demonstrate our technique by explicitly computing optimal policies in a series of examples in particular we solve the optimal consumption portfolio problem for hyperbolic absolute risk aversion utility functions when the asset prices follow a geometric brownian motion the optimal policies in this case are no longer linear when nonnegativity constraints on consumption and on final wealth are included by these examples one can see that our approach is much easier than the dynamic programming approach

dynamics of the trade balance and the terms of trade the j curve the authors provide a theoretical interpretation of two features of international data the countercyclical movements in net exports and the tendency for the trade balance to be negatively correlated with current and future movements in terms of trade but positively correlated with past movements they document the same properties in a two country stochastic growth model in which trade fluctuations reflect in large part the dynamics of capital formation the authors find that their general equilibrium perspective is essential the relation between the trade balance and the terms of trade depends critically on the source of fluctuations copyright 1994 by american economic association

consumption and real exchange rates in dynamic economies with non traded goods abstract we examine the possibility that non traded goods may account for several striking features of international macroeconomic data large persistent deviations from purchasing power parity small correlations of aggregate consumption fluctuations across countries and substantial international real interest rate differentials a dynamic exchange economy is used to show that non traded goods in principle can account for each of these phenomena in the theory there is a close relation between fluctuations in consumption ratios and those in bilateral real exchange rates but we find little evidence for this relation in time series data for eight oecd countries

institutional investors and stock market volatility statement of responsibility on t p reads xavier gabaix parameswaran gopikrishnan vasiliki plerou h eugene stanley

deep habits and exchange rate pass through abstract habit persistence at the level of individual goods varieties can explain incomplete exchange rate pass through to international prices deep habits give rise to a dynamic import demand function that leads to import price markup adjustments independently of nominal pricing frictions augmenting a two country dsge model with deep habits we obtain low exchange rate pass through to import prices even when nominal local currency price rigidities are negligibly low as nominal pricing frictions become more important the presence of deep habits further impedes the pass through of exchange rate fluctuations estimating model variants with limited information as well as full information methods we find that the deep habits model requires much lower degrees of nominal price rigidities to match empirical measures of the pass through of exchange rate fluctuations to us import prices

fifth order perturbation solution to dsge models abstract this paper derives a fifth order perturbation solution to dsge models the paper develops a new notation that reduces the notational complexity of high order solutions and yields a faster code the new notation consists of new matrix forms of high order multivariate chain rules and a new representation of the model as a function of one vector variable the algorithm that implements the new notation is between 3 and 55 times faster than dynare depending on model size and solution order

financial intermediation international risk sharing and reserve currencies abstract i model the equilibrium risk sharing between countries with varying financial development the most financially developed country takes greater risks because its financial intermediaries deal with funding problems better in good times the more financially developed country consumes more and runs a trade deficit financed by the higher financial income that it earns as compensation for taking greater risk during global crises it suffers heavier losses its currency emerges as the reserve currency because it appreciates during crises thus providing a good hedge i provide evidence that financial net worth plays a crucial role in understanding this asymmetric risk sharing jel e44 f14 f32 g01 g15 g21

better statistics better economic policies abstract more and more economic transactions leave a digital footprint this trend opens unprecedented opportunities for improving economic statistics and underpins demands to give statistical agencies far reaching access to private sector data we analyze the consequences of better economic statistics in a political agency framework that includes fundamental uncertainty about the impact of potentially welfare enhancing reforms we demonstrate that improvements in economic statistics can inhibit rather than stimulate reform attempts with better statistics the government is less likely to receive the benefit of the doubt if the numbers suggest its past reforms are failing reforms therefore come with a higher risk of electoral losses implying that the government has stronger incentives to preserve the status quo we identify political environments that are particularly vulnerable to this mechanism and contribute to the debate on private sector data access

is there a peso problem evidence from the dollar pound exchange rate 1976 1987 one of the most puzzling aspects of the floating exchange rate regime since 1973 has been the apparent irrationality embedded in investors exchange rate expectations this paper investigates whether exchange rate forecasts although biased are still rational the idea is that investors can be rational and yet make repeated mistakes if the true model of the exchange rate is evolving over time the author s results support the hypothesis that the exchange rate has followed a switching regime process moreover the switching regime model estimated can explain about 75 percent of the bias implied by the forward market and the survey data copyright 1993 by american economic association

equilibrium asset prices and exchange rates abstract in a two country two good world we construct an intertemporal international general equilibrium for two logarithmic representative agents financial markets are fully integrated and independently incomplete the equilibrium expected rate of change of the exchange rate increases with the differential of interest rates and the volatility of the domestic equity markets and decreases with the covariance between domestic and foreign equity markets the equilibrium volatility of the exchange rate is the sum of the volatilities due to idiosyncratic factors in the financial markets and a term that represents the difference of weights in the common international factor

real exchange rate persistence and country characteristics a global analysis abstract this paper examines the persistence of real exchange rates across 151 countries we employ univariate time series techniques on a country by country basis allowing for deterministic structural breaks and nonlinearities in the adjustment process our findings suggest that bilateral exchange rates display higher rates of persistence than multilateral exchange rates with the latter former exhibiting half lives of less than 1 2 year s assessing country results by stage of economic development we find that industrial countries display higher levels of exchange rate inertia than developing countries we retrieve evidence indicating that higher inflation nominal exchange rate volatility trade openness and proximity to reference country are associated with faster rates of real exchange rate convergence conversely international financial integration is found to only play a role at the country group level with differential effects across cohorts

risk sharing and counter cyclical variation in market correlations abstract i present a consumption based dynamic asset pricing model in which international market correlations vary counter cyclically over time the driving force in the model is the time varying effective risk aversion induced by external habit formation market returns are driven by fundamental outputs and discount rates when risk aversion is high the effect of discount rates on market returns rises with the market price of risk to the extent that countries share risk the cross country correlation of discount rates exceeds the cross country correlation of fundamental outputs in bad times market correlations rise as returns are mostly driven by discount rates thus consistent with the empirical evidence periods of high risk aversion are associated with high market correlations and high market volatility after calibration my model is consistent with the observed variation in market correlations as well as other features of asset prices including the equity premium and market volatility

implied exchange rate distributions evidence from otc option markets abstract this paper uses a rich new dataset of option prices on the dollar mark dollar yen and key ems cross rates to extract the entire risk neutral probability density function pdf over horizons of 1 and 3 months we compare three alternative smoothing methods cubic splines an implied binomial tree trimmed and untrimmed and a mixture of lognormals for transforming option data into the pdf despite their methodological differences the three approaches lead to a similar pdf clearly distinct from the lognormal benchmark and typically characterized by skewness and leptokurtosis we then document a striking positive correlation between skewness in these pdfs and the spot rate the stronger a currency the more expectations are skewed towards a further appreciation of that currency we interpret this finding as a rejection that innovations in these exchange rates are independent of the level or characteristic of a credible target zone explicit or implicit instead this positive correlation is consistent with target zones with endogenous realignment risk we discuss two interpretations of our results on skewness when a currency is stronger the actual probability of further large appreciation is higher or because of risk such states are valued more highly

the time variation of risk and return in foreign exchange markets a general equilibrium perspective this article successively introduces variable velocity durability and habit persistence in a standard two country general equilibrium model and explores their effects on the variability of exchange rate changes forward premiums and the foreign exchange risk premium a new feature of the model is that agents make decisions at a weekly frequency and face conditionally heteroskedastic shocks nevertheless even the most complex model fails to deliver sufficiently variable risk premiums without causing forward premiums and exchange rates to be excessively variable unlike previous models the model can roughly match the persistence of forward premiums article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

learning and asset price jumps w e develop a general equilibrium model in which income and dividends are smooth but asset prices contain large moves jumps these large price jumps are triggered by optimal decisions of investors to learn the unobserved state we show that learning choice is determined by preference parameters and the conditional volatility of income process an important model prediction is that income volatility predicts future jump periods while income growth does not consistent with the model large moves in returns in the data are predicted by consumption volatility but not by consumption growth the model quantitatively captures these novel features of the data jel g00 g12 g14 d83 a prominent feature of financial markets is infrequent but large price movements jumps 1 in this article we develop a model in which income and dividends have smooth gaussian dynamics however asset prices are subject to large infrequent jumps in our model large moves in asset prices obtain from the actions of the representative agent to acquire more information about the unobserved state of the economy for a cost we show that the optimal decision to incur a cost and learn the true economic state is directly related to the level of uncertainty in the economy this implies that aggregate economic volatility as well as market volatility should predict jumps in returns we show that indeed in the data consistent with the model return jumps are predicted by consumption volatility market volatility further the implied asset price implications from our model are consistent with the key findings from parametric models about frequency and predictability of jumps as well as nonparametric jump detection analysis of barndorff nielsen and shephard 2006 based on

rethinking an old empirical puzzle econometric evidence on the forward discount anomaly using both semiparametric and parametric estimation methods this paper corroborates earlier findings of fractionally integrated behaviour in the forward premium two new explanations are also proposed to help reconcile earlier conflicting empirical evidence on the time series properties of the forward premium traditional regression approaches used to test the forward rate unbiasedness hypothesis are then evaluated including regression in levels in returns fama s 1984 regression and in error correction format interesting statistical and or interpretive implications are found in all three cases for example the predictions of the appropriate nonstandard limit theory are consistent with many of the standard empirical results reported from fama s regression including the commonly occurring yet puzzling negative correlations between spot returns and the forward premium it is suggested that the principal failure of unbiasedness may be due instead to the difference in persistence between these two series copyright 2001 john wiley sons ltd

asset prices and real exchange rates with deep habits i introduce an external habit for each consumption good known as deep habits into an otherwise standard international equilibrium model with multiple consumption goods and multiple countries i show that deep habits coupled with consumption home bias account for a wide range of asset pricing and exchange rate moments calibrated to a set of ten countries the model reproduces the cross sectional evidence on currency risk premiums when sorting on interest rates interest rate volatility innovations to global exchange rate volatility and value hence the model provides an equilibrium interpretation of these empirical regularities

a theory of dissimilarity between stochastic discount factors this paper proposes a measure of dissimilarity between stochastic discount factors sdfs in different economies the sdfs are made comparable using the respective bond prices as the numeraire the

gain loss asymmetric stochastic differential utility abstract this study examines a gain loss asymmetric utility in continuous time in which the investor discounts their utility gain by more than the utility loss by employing the theory of stochastic differential utility the model allows an endogenously time varying subjective discount rate in addition the model can express various forms of utility functions including a version of the epstein zin utility under the model even if the state variables do not have any jump in their paths the optimal consumption wealth ratio and portfolio weight can change non smoothly

the term structure of inflation expectations we use information in the term structure of survey based forecasts of inflation to estimate a factor hidden in the nominal yield curve we construct a model that accommodates forecasts over multiple horizons from multiple surveys and treasury real and nominal yields by allowing for differences between risk neutral subjective and objective probability measures we establish that model based inflation expectations are driven by inflation output and one latent factor we find that this factor affects inflation expectations at all horizons but has almost no effect on the nominal yields that is the latent factor is hidden we show that this hidden factor is not related to either current and past inflation or the standard set of macro variables studied in the literature consistent with the theoretical property of a hidden factor our model outperforms a standard macro finance model in its forecasting of inflation and yields

accounting for u s real exchange rate changes this study measures the proportion of u s real exchange rate movements that can be accounted for by movements in the relative prices of nontraded goods the decomposition is done at all possible h

earmarked taxation and political competition abstract although tax earmarking constitutes a voluntary constraint for government s policymaking it is widely used in the real world this paper investigates the electoral dimension of earmarking in a model of political competition with ideological parties its main contribution is to derive new insights on the relationship between earmarking and parties probability of winning the elections we find that the electoral pressure may favor the existence of tax earmarking equilibria but that it sometimes creates a tendency against earmarked taxation even when as shown by brett and keen 2000 brett c keen m 2000 political uncertainty and the earmarking of environmental taxes journal of public econonomics 75 315 340 incumbent governments have strong incentives to use earmarking rules to constrain future policymakers

country size currency unions and international asset returns differences in real interest rates across developed economies are puzzlingly large and persistent i propose a simple explanation bonds issued in the currencies of larger economies are expensive because they insure against shocks that affect a larger fraction of the world economy i show that indeed differences in the size of economies explain a large fraction of the cross sectional variation in currency returns the data also support additional implications of the model the introduction of a currency union lowers interest rates in participating countries and stocks in the nontraded sector of larger economies pay lower expected returns

liquidity risk and time varying correlation between equity and currency returns using data on twenty major oecd countries over time this paper documents a new evidence on real equity and real currency prices higher real returns in the home equity market relative to foreign counterparts are generally associated with real home currency depreciation at a monthly frequency but this negative correlation breaks down or even reverses during times of relatively higher aggregate economic uncertainty or volatility this paper also proposes one plausible explanation for this time varying correlation structure the suggested model is based on a long run risks type model combined with time varying liquidity risks in stock markets with recursive preference for the early resolution of uncertainty and a negative link between the level of short run economic growth and equity market liquidity volatility the model demonstrates that severe short run economic uncertainty overturns the otherwise negative link between the real currency and real relative equity returns

why are exchange rates so smooth a household finance explanation abstract empirical moments of asset prices and exchange rates imply that pricing kernels are almost perfectly correlated across countries otherwise observed real exchange rates would be too smooth for high sharpe ratios however the cross country correlation among macro fundamentals is weak we reconcile these facts in a two country stochastic growth model with heterogeneous households and a home bias in consumption in our model only a small fraction of households trade domestic and foreign equities we show that this mechanism can quantitatively account for the smoothness of exchange rates in the presence of volatile pricing kernels and weakly correlated macro fundamentals

microeconomic origins of macroeconomic tail risks we document that even though the normal distribution provides a good approximation to gdp fluctuations it severely underpredicts macroeconomic tail risks that is the frequency of large economic downturns using a multi sector general equilibrium model we show that the interplay of idiosyncratic microeconomic shocks and sectoral heterogeneity results in systematic departures in the likelihood of large economic downturns relative to what is implied by the normal distribution notably we also show that such departures can happen while gdp is approximately normally distributed away from the tails highlighting the qualitatively different behavior of large economic downturns from small or moderate fluctuations we further demonstrate the special role that input output linkages play in generating tail comovements whereby large recessions involve not only significant gdp contractions but also large simultaneous declines across a wide range of sectors

rare disasters and risk sharing with heterogeneous beliefs risks of rare economic disasters can have a large impact on asset prices at the same time difficulties in inference regarding both the likelihood and severity of disasters as well as agency problems can lead to significant disagreements among investors about disaster risk we show that such disagreements generate strong risk sharing motives such that just a small number of optimists in the economy will significantly reduce the disaster risk premium our model highlights the latent nature of disaster risk the disaster risk premium will likely be low and smooth during normal times but increases dramatically when the risk sharing capacity of the optimists is reduced e g following a disaster the model also helps reconcile the difference in the amount of disaster risk implied by financial markets and international macroeconomic data and provides caution to the approach of extracting disaster probabilities from asset prices which will disproportionately reflect the beliefs of a small group of optimists finally our model predicts an inverse u shaped relation between the equity premium and the size of the disaster insurance market the author 2012 published by oxford university press on behalf of the society for financial studies all rights reserved for permissions please e mail journals permissions oup com oxford university press

inflation targeting and the forward bias puzzle in emerging countries abstract based on quarterly data on 31 emerging countries among which 16 are inflation targeting countries from 1990q1 to 2014q3 we obtain a strong support for the conjecture that the implementation of inflation targeting weakens the fisherian relation between expected depreciation and the interest rate differential uncovered interest parity condition and thus is conducive to the appearance of the forward bias puzzle in emerging countries we show that this reflects the performance of inflation targeting regimes in lowering the level and volatility of inflation our finding holds when controlling for country specific effects time specific effects global disinflation exchange rate management crises and using different econometric techniques

international real business cycles we ask whether a two country real business cycle model can account simultaneously for domestic and international aspects of business cycles with this question in mind we document a number of discrepancies between theory and data the most striking discrepancy concerns the correlations of consumption and output across countries in the data outputs are generally more highly correlated across countries than consumptions in the model we see the opposite

disasterization a simple way to fix the asset pricing properties of macroeconomic models a central difficulty in economics is to create a model with both good business cycle properties and asset pricing properties i show how to solve this difficulty by a simple portable modeling device the disasterization of models take an economy with good business cycle properties and create a new disasterized economy which is essentially identical to the original one except that disasters can destroy part of the capital stock and productivity in such a disasterized economy asset prices exhibit high and volatile risk premia but macro variables remain unchanged perturbations of this benchmark allow for feedback from finance to macro