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

standard risk aversion this paper introduces the concept of standard risk aversion a von neumann morgenstern utility function has standard risk aversion if any risk makes a small reduction in wealth more painful in the sense of an increased reduction in expected utility also makes any undesirable independent risk more painful it is shown that given monotonicity and concavity the combination of decreasing absolute risk aversion and decreasing absolute prudence is necessary and sufficient for standard risk aversion standard risk aversion is shown to imply not only pratt and zeckhauser s proper risk aversion individually undesirable independent risks always being jointly undesirable but also that being forced to face an undesirable risk reduces the optimal investment in a risky security with and independent return similar results are established for the effect of broad class of increases in one risk on the desirability of or optimal investment in a second independent risk

inventory control with product returns the impact of imperfect information product returns are characterized by considerable uncertainty on time and quantity in the literature on inventory management for product return environments best forecasts of future returns are associated with methods that use the most information regarding product return history in practice however data is often scarce and unreliable while forecasts based on historical data reliable or not are never perfect in this paper we therefore investigate the impact of imperfect information with respect to the return process on inventory management performance we show that in the case of imperfect information the most informed method does not necessarily lead to best performance the results have relevant implications regarding investments in product return information systems

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

valuation and optimal exercise of the wild card option in the treasury bond futures market the chicago board of trade treasury bond futures contract allows the short position several delivery options as to when and with which bond the contract will be settled the timing option allows the short position to choose any business day in the delivery month to make delivery in addition the contract settlement price is locked in at 2 00 p m when the futures market closes despite the facts that the short position need not declare an intent to settle the contract until 8 00 p m and that trading in treasury bonds can occur all day in dealer markets if bond prices change significantly between 2 00 and 8 00 p m the short has the option of settling the contract at a favorable 2 00 p m price this phenomenon which recurs on every trading day of the delivery month creates a sequence of 6 hour put options for the short position which has been dubbed the wild card option this paper presents a valuation model for the wild card option and computes estimates of the value of that option as well as rules for its optimal exercise the treasury bond futures contract on the chicago board of trade gives several delivery options to the short position the quality option which allows the short to deliver any of several eligible delivery bonds has already been studied fairly extensively because many bonds are eligible to be delivered against the futures contract and the conversion factors used to adjust for the bond actually delivered do not perfectly reflect relative price differences the short side trader will choose to deliver the cheapest eligible bond kilcollin 71 presents a discussion and analysis of conversion factors and their effects on the optimal delivery bond gay and manaster 4 present a theoretical valuation model for the quality option when two classes of commodities with uncertain end of period spot prices may be delivered garbade and silber 3 provide a similar analysis and estimate parameters of the valuation formula for a variety of agricultural commodity futures kane and marcus 6 have used monte carlo simulations to value the quality option in the treasury bond futures market in contrast the various timing options embedded in the delivery process have received comparatively little attention one of the most important of these is the so called wild card option the wild card option arises because the futures market closes each trading day at 2 p m central standard time which locks in the futures settlement price for the rest of the day while the short trader has until 8 p m of each trading day in the delivery month to declare an intent to deliver

were price changes during the great depression anticipated abstract this paper reassesses whether the large swings in prices during the 1930 s were anticipated we argue that uncertainty about monetary fiscal and exchange rate policies induced systematic differences between the rate of price change expected by economic agents at the time and the time series forecasts of inflation our analysis of nominal interest rates and ex post inflation strongly supports this view in fact our results suggest that the deflation of the early depression years and the inflation that followed were both largely unanticipated

do markets learn to rationally expect us interest rates an anchoring approach we propose an augmented and dynamic forecast anchoring model to examine whether a group of rational forecasters coexists with or emerges besides a group of forecasters employing heuristic rules th

a strategic analysis of sinking fund bonds abstract unlike most securities the pricing of sinking fund bonds is influenced by the distribution of ownership which summarizes the extent to which the market is cornered the effect of the distribution of ownership on the pricing of sinking fund bonds is examined by an explicit game in which the price obtained for bonds sold can depend upon the size of the investor s position this framework is used to contrast the valuation of sinking fund bonds with the valuation of amortizing bonds and straight debt we show that it is generally incorrect to view sinking fund bonds as being equivalent to serial bonds

seasonal fluctuations and the life cycle permanent income model of consumption this paper examines a new possible explanation for the recent rejections of the life cycle permanent income model of consumption the treatment of seasonal fluctuations the paper shows that when the seasonal fluctuations in consumption purchases are included in an analysis of the life cycle permanent income model there is no evidence in the aggregate data against the model the estimates of the parameters of agents utility functions obtained with seasonally unadjusted data are plausible and the unadjusted data do not reject the overidentifying restrictions on the model

an empirical analysis of implicit delivery options in the treasury bond futures contract abstract assuming perfect frictionless and efficient markets this paper develops a framework to estimate the composite value of the quality wild card and end of month options implicit in the t bond futures contract the value of delivery options is shown to be the excess of forward price of the cheapest bond over its conversion factor times the exercise price of futures contract empirical results indicate that the option values over the last quarter of the nearby contract are on average less than 0 5 percent of the mean futures price which is substantially lower than the value reported by previous studies further scrutiny reveals that although the empirical estimates are contaminated by non synchronous bond data they are consistent with certain known theoretical properties of option values

bond and stock returns in a simple exchange model this paper studies asset pricing in a general equilibrium representative agent exchange model the assumptions of isoelastic period utility and lognormal endowment allow the derivation of closed form solutions for asset returns without restricting the serial correlation of the log endowment risk premiums on stocks and real bonds are found to be simple functions of relative risk aversion the variance of the log endowment innovation and the weights in the moving average representation of the log endowment the paper analyzes the sign of term premiums the size of the equity premium and the effect of taste shocks on asset prices

on stabilizing volatile product returns as input ows of secondary raw materials show high volatility and tend to behave in a chaotic way the identification of the main drivers of the dynamic behavior of returns plays a crucial role based on a stylized productionrecycling system consisting of a set of nonlinear difference equations we explicitly derive parameter constellations where the system will or will not converge to its equilibrium using a constant elasticity of substitution production function the model is then extended to enable coverage of real world situations using waste paper as a reference raw material we empirically estimate the parameters of the system by using these regression results we are able to show that the equilibrium solution is a lyapunov unstable saddle point this implies that the system is sensitive on initial conditions that will hence impede the predictability of product returns small variations of production input proportions could however stabilize the whole system authors abstract

information distortion in a supply chain the bullwhip effect this article originally appeared in management science april 1997 volume 43 number 4 pp 546 558 published by the institute of management sciences consider a series of companies in a supply chain each of whom orders from its immediate upstream member in this setting inbound orders from a downstream member serve as a valuable informational input to upstream production and inventory decisions this paper claims that the information transferred in the form of orders tends to be distorted and can misguide upstream members in their inventory and production decisions in particular the variance of orders may be larger than that of sales and distortion tends to increase as one moves upstream a phenomenon termed bullwhip effect this paper analyzes four sources of the bullwhip effect demand signal processing rationing game order batching and price variations actions that can be taken to mitigate the detrimental impact of this distortion are also discussed

delivery uncertainty and the efficiency of futures markets this paper examines the effects of the delivery basis risk embedded in nearly all futures contracts on efficiency tests of these markets examining soybean futures contracts we show that delivery basis risk has important implications for market efficiency tests as suming no delivery basis risk the market efficiency hypothesis is rejected however fu tures prices contain signiflcant time varying expected delivery basis and time varying ex pected delivery risk premiums once these expected delivery basis and delivery risk premiums are accounted for the apparent inefficiency is eliminated equilibrium spot prices also contain signiflcant time varying expected delivery risk premiums

the value of wildcard options wildcard options are embedded in many derivative contracts they arise when the settlement price of the contract is established before the time at which the wildcard option holder must declare his intention to make or accept delivery and the exercise of the wildcard option closes out the underlying asset position this paper provides a simple method for valuing wildcard options and illustrates the technique by valuing the sequence of wildcard options embedded in the s p 100 index oex option contract the results show that wildcard options can account for an economically significant fraction of oex option value many exchange traded derivative securities contain embedded delivery

information distortion in a supply chain the bullwhip effect commentary consider a series of companies in a supply chain each of whom orders from its immediate upstream member in this setting inbound orders from a downstream member serve as a valuable informational input to upstream production and inventory decisions this paper claims that the information transferred in the form of orders tends to be distorted and can misguide upstream members in their inventory and production decisions in particular the variance of orders may be larger than that of sales and distortion tends to increase as one moves upstream a phenomenon termed bullwhip effect this paper analyzes four sources of the bullwhip effect demand signal processing rationing game order batching and price variations actions that can be taken to mitigate the detrimental impact of this distortion are also discussed

day of the week effects in financial futures an analysis of gnma t bond t note and t bill contracts this paper provides a comprehensive study of weekly seasonal effects in gnma t bond t note and t bill futures returns two distinct patterns are found in returns on gnma t bond and t note contracts while no seasonals are noted for t bill futures a negative monday seasonal similar to the well known monday effect in stock returns is found for gnma and t bond contracts a positive tuesday seasonal is found on gnma t bond and t note contracts our evidence indicates that the significance of weekly sea sonals depends in an important way on the time period studied the negative monday phenomenon occurs only in the data before 1982 while the positive tuesday effect is present only after 1984 in addition we find that both seasonal phenomena occur only during months prior to a delivery month this effect appears to be related to the calendar month more specifically the monday effect is apparently concentrated during february while the tuesday effect is concentrated during may

an ex post valuation of the quality option implicit in the treasury bond futures contract abstract this paper develops three empirical estimates of the value of the quality delivery option implicit in the treasury bond futures contract a an ex ante value as given by the excess of forward price of the cheapest to deliver bond over its conversion factor times the futures price b an ex post value equal to the payoffs to a strategy of buying and holding a short futures long forward position at the start and delivering the cheapest bond at the expiration of futures contract and c another ex post value equal to the sum of payoffs to a continuous rollover strategy involving a short futures long forward position in the cheapest to deliver bonds three months prior to delivery the average values of the three estimates are 464 329 and 2 075 respectively the differences among the three estimates appear to be largely due to nonsynchronous spot futures data

the quality delivery option in treasury bond futures contracts this paper uses three methods to estimate quality option values for cbot treasury bond futures contracts it presents evidence regarding 1 payoffs from exercising this option at delivery 2 estimates from a t bond futures pricing model that incorporates this option and 3 estimates obtained from an exchange option pricing formula the results indicate that this option is worth considerably less than reported by kane and marcus 1986a for example payoffs obtained by switching from the bond cheapest to deliver three months prior to delivery to the one cheapest at time of delivery average less than 0 30 percentage points of par

liquidity constrained exporters and trade abstract we present a model of a risk averse exporting firm subject to liquidity constraints we show that preferences and expectations become important for optimum export and hedging decisions only firms that have sufficient financial resources can fully materialize gains from trade

a discounted cash flow model of convertibles subject to multiple calls in a world of refunding costs and stochastic interest rates fixed income securities which can be converted into other assets such as common stock represent a sizable portion of the capital market 33 and have therefore received frequent attention in the financial literature 20 21 23 35 39 however due to their complexity attempts to develop mathematical models of convertibles have encountered severe computational and theoretical difficulties 36 one of the primary complications results from convertible securities generally having contractual call features which permit the issuing organization to redeem the securities at stipulated dates for specific prices in addition although a majority of convertibles listed in moody s bond guide have sinking funds the issue of analyzing convertible sinking fund calls represents a specific problem that has never been adequately addressed early studies of convertibles such as brigham 10 focused on the discounted cash flow approach to valuing the securities the general procedure was to estimate a terminal price for the convertible on an arbitrarily specified date in the future and then take the present value of the price together with all intervening fixed income payments these models lacked precision insofar as no theoretical framework was developed for specifying the relevant terminal date terminal price or discount rate and the individual effect of each call feature on convertible values was largely ignored other research such as walter and que 38 has employed regression analysis to pro

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

international trade with forward futures markets under exchange rate and price uncertainty abstract the paper examines a risk averse firm s decisions on the level of trade when the exchange rate and the commodity price are uncertain and the extent of forward exchange and commodity futures commitments first we verify the separation theorem and the full double hedging theorem second we investigate the implications of the existence of both forward foreign exchange and commodity futures markets in comparison to the case where only one or no market is available to the firm the second exercise enables us to focus on conditions under which establishing forward futures arrangements promotes international trade

financial constraints competition and hedging in industry equilibrium we analyze the hedging decisions of firms within an equilibrium setting that allows us to examine how a firm s hedging choice depends on the hedging choices of its competitors within this equilibrium some firms hedge while others do not even though all firms are ex ante identical the fraction of firms that hedge depends on industry characteristics such as the number of firms in the industry the elasticity of demand and the convexity of production costs consistent with prior empirical findings the model predicts that there is more heterogeneity in the decision to hedge in the most competitive industries

corporate bond price data sources and return risk measurement to date a number of studies involving the use of bond prices and or returns have utilized the published prices of trades on the new york and other exchanges these exchange quotes reflect the odd lot activities of individual investors and account for only a negligible portion of the trading in listed issues in contrast the vast majority of listed corporate trading occurs over the counter and involves round lot trades between institutions given differences in market characteristics odd lot exchange prices may differ substantially from those in the round lot institutional market this study compares exchange quotations from moody s bond record with prices assigned by merrill lynch s institutional pricing service and uses each set of prices to calculate return and risk measures institutional merrill lynch bond prices are shown to be systematically greater than exchange moody s prices in addition bond returns based on merrill lynch prices are shown to yield significantly higher beta and r 2 estimates as well as significantly lower standard deviation and residual risk estimates

strategic trading behavior and price distortion in a manipulated market anatomy of a squeeze abstract this paper investigates an attempted delivery squeeze in a bond futures contract traded in london using cash and futures trades of dealers and customers we analyze their strategic trading behavior price distortion and learning in a market manipulation setting we argue that marked differences in settlement failure penalties in the cash and futures markets create conditions that favor squeezes we recommend that regulators require special flagging of forward term repurchase agreements on the key deliverables that span futures contract maturity dates and that exchanges mark to market their contract specifications more frequently or consider a cash settled contract on a basket of bonds

discovering the link between inflation rates and inflation uncertainty a new time series model is used to reassess the strength of the link between inflation uncertainty and the level of inflation in the united states the model provides several statistical measures that can be used to examine different aspects of uncertainty the main finding is that uncertainty about the long rather than short term prospects for inflation moved strongly with the rate of inflation since the early 1970s copyright 1991 by ohio state university press

the expectations hypothesis new hope or illusory support abstract recent studies of the expectations hypothesis of the term structure ehts find evidence in favor of the ehts using post 1980s us data this has been attributed to the relative macro stability of this period and greater market efficiency using a panel of forecasts for 3 month interest rates for ten countries we test separately for ehts and rational expectations assuming rational expectations holds we find support for the ehts is illusory due to an off setting time varying term premia and non rational expectations previous forecast based studies suggest biased expectations tend to reinforce the effect of a time varying term premium this change can be understood in the context of fama s 2006 argument that markets tend to underestimate future spot rates during periods of long run increases and overestimate during declines

multiperiod production with forward and option markets production and hedging in both forward and options markets are analyzed for forward looking firms that maximize expected utility in the presence of unbiased forward and options prices it is shown that such firms will use options as hedging instruments this result contrasts with the conclusions from studies that assume myopic behavior and occurs because forward looking agents care about the effect of future output prices on profits from future production cycles simulations support the theoretical results and show how the introduction of an options market influences the optimal forward position

market expectations in the uk before and after the erm crisis the british pound left the erm on 16 september 1992 after a period of turbulence uk monetary policy soon shifted to lower short interest rates and an inflation target was announced this paper uses daily option prices to estimate how the market s probability distribution of the future marks pound exchange rate and uk and german interest rates changed over the summer and autumn of 1992 the results show among other things how various policy decisions affected the market s assessment of the probabilities of realignments and lending rate cuts

the default rate experience on high yield corporate debt recent 1978 83 net returns on high yield low rated debt have been impressive averaging 490 to 580 basis points above the long term government bond index but low rated junk bonds pose a risk of default not present in the higher rated segment of the bond market the authors divided the par value of defaulting debt by total low rated straight debt outstanding to arrive at an estimate of the default rate for high yield bonds excluding johns manville which had the only defaulting debt rated investment grade just prior to the default date for the 1974 84 period this averaged 1 52 per cent or 152 basis points annually year to year variations in the rate were substantial furthermore default experience differed across various industry segments railroads and reits were particularly vulnerable to default in the past although they are unlikely to represent a large portion of future defaults retailer electronic computer airline and oil and gas defaults have become more common in recent years losses from default are actually lower than the default rate alone implies defaulted bonds traded on average at 41 per cent of par shortly after default after accounting for the bonds retained value and the loss of interest the average reduction in return to the investor who had purchased the bonds at par would have been in the range of 96 to 100 basis points annually

the econometric analysis of models with risk terms summary in this paper we have attempted to provide an integrated approach to the estimation of models with risk terms it was argued that there exist orthogonality conditions between variables in the information set and higher order moments of the unanticipated variable density these could be exploited to provide consistent estimators of the parameters associated with the risk term specifically it was recommended that an iv estimator should be applied with instruments constructed from the information set four existing methods commonly used to estimate models with risk terms are examined and applications of the techniques are made to the estimation of the risk term in the us c exchange market and the effects of price uncertainty upon production

the time varying behaviour of real interest rates a re evaluation of the recent evidence a time varying parameter model with markov switching conditional heteroscedasticity is employed to investigate two sources of shifts in real interest rates 1 shifts in the coefficients relating the ex ante real rate to the nominal rate the inflation rate and a supply shock variable and 2 unconditional shifts in the variance of the stochastic process the results underscore the importance of modelling continual change in the ex ante real rate in terms of other economic variables rather than relying on a statistical characterization that permits only a limited number of discrete jumps in the mean of the process copyright 1999 john wiley sons ltd

testing the rationality of price forecasts new evidence from panel data this paper tests the rationality of individual price forecasts in a panel of professional forecasters here unlike in most previous studies rationality is not rejected the results here differ because 1 using individual forecasts avoids aggregation bias 2 comparison of forecasts to initial data avoids bias due to data revision 3 the professional forecasters have economic incentives to state their expectations accurately and 4 a new covariance matrix estimator consistent when forecast errors are correlated across individuals is used copyright 1990 by american economic association

indirect hedging of exchange rate risk abstract the purpose of this study is to investigate the impact of exchange rate risk upon export production when the firm cannot engage in a direct forward hedge in the exchange rate however there exists a forward market for a domestic financial asset correlated with the exchange rate in question exporting firms using such an indirect hedging device to reduce foreign exchange risk do not necessarily increase their output when such unbiased hedging market becomes available this contrasts with the well known result in the case of direct hedging

optimal hedging in futures markets with multiple delivery specifications nearly all futures contracts allow delivery of any of several qualities of the underlying asset consequently the price of the futures contract is associated more with the price of the expected cheapest deliverable variety than with the price of the par delivery variety the delivery specifications introduce a delivery risk for every hedger in the market we derive the optimal hedging strategies in these markets their hedging effectiveness is evaluated for wheat futures contracts in chicago hedging optimally would have significantly reduced the variance of the rates of return on hedges while yielding similar mean returns nearly all futures contracts on commodities and financial assets allow the seller to deliver any of several qualities of the underlying asset the contracts specify discounts or premiums for delivering a nonpar quality but the realized price differences can be significantly different consequently the futures price on a delivery date converges to the spot price of the quality that is cheapest to deliver rather than the spot price of the par delivery quality since it is uncertain which quality will be the cheapest to deliver this introduces a delivery risk for every hedger in the market gay and manaster 9 and kane and marcus 13 find that hedgers in the treasury bond futures market have neither hedged nor exploited the delivery specifications in an optimal way 1 this paper addresses how to hedge optimally in futures markets with multiple delivery specifications 2 we derive the optimal hedging strategies and evaluate their hedging effectiveness futures markets are hedging markets working 20 they enable traders to hedge the risk of unexpected changes in the spot price of their asset the hedging effectiveness of futures markets is therefore an important issue earlier studies include ederington 3 figlewski 5 and koppenhaver 16 among others this study also differs from those studies in that we evaluate an ex ante hedging

new hope for the expectations hypothesis of the term structure of interest rates survey data on interest rate expectations permit separate testing of the two alternative hypotheses in traditional term structure tests that the expectations hypothesis fails and that expected future interest rates are ex post inefficient forecasts we find that the source of the spread s poor predictions of future interest rates varies with maturity at short maturities the expectations hypothesis fails at long maturities however changes in the yield curve reflect changes in expected future rates one for one an implication of the expectations hypothesis this result confirms earlier findings that long rates underreact to short rates but now it cannot be attributed to term premia if the attractiveness of an economic hypothesis is measured by the number of papers which statistically reject it the expectations theory of the term structure is a knockout most tests beginning with macaulay 1938 find no evidence supporting the expectations hypothesis 1 many cannot even reject statistically the alternative hypothesis that the spread between long and short rates contains no information about future interest rate changes 2 to make matters worse in u s postwar data future long rates tend to rise when short rates are above long rates since the expectations hypothesis would predict that long rates tend to fall the theory often does worse than even the naive model that future interest

difference systems in financial futures markets many financial futures markets allow substitutions for the par grade of security at delivery substitutes are deliverable at premiums or discounts differences in commodities parlance to the futures price the rule that establishes these differences is called a difference system this paper characterizes financial futures market equilibrium with yield based difference systems and investigates particular systems in use the major finding is that currently used difference systems effectively limit deliverable supply in the futures markets and lead to futures prices which understate the cash market price of the par security in order to increase deliverable supply many financial futures markets allow the delivery of a variety of grades issues of securities in fulfillment of a financial futures contract the par grade of security on which the futures contract is based is deliverable at the futures price various other grades of securities are deliverable at premiums or discounts to the futures price in commodities parlance these premiums and discounts are called differences and the rule that establishes the set of premiums and discounts is called a difference system see hoffman 2 chapter xv for an excellent discussion of difference systems in commodity futures contracts there are two types of difference systems currently in use in financial futures markets both are based on security yields the first is called variable rate or yield maintenance pricing under this system nonpar securities are deliverable at the futures price times a factor which is the price of the delivered security relative to the par security where both are discounted by the yield of the par security selling at the futures price the second is called fixed rate or factor pricing under this system nonpar securities are deliverable at the futures price times a factor which is the price of the delivered security relative to the par security where both are discounted at the yield of the par security selling at par this paper first characterizes financial futures market equilibrium with yieldbased difference systems and then investigates theoretically and empirically the particular characteristics of factor pricing and yield maintenance pricing the major finding is that currently used differences systems produce financial futures prices which systematically understate the spot market price of the par security vice president chicago mercantile exchange this research was conducted while the author was economist financial studies section board of governors of the federal reserve system the opinions in this paper are those of the author and do not necessarily reflect the opinions of the board

a defense of traditional hypotheses about the term structure of interest rates expectations theories of asset returns may be interpreted either as stating that risk premia are zero or that they are constant through time under the former interpretation different versions of the expectations theory of the term structure are inconsistent with one another but i show that this does not necessarily carry over to the constant risk premium interpretation of the theory i present a general equilibrium example in which different types of risk premium are constant through time and dependent only on maturity furthermore i argue that differences among expectations theories are secondorder effects of bond yield variability i develop an approximate linearized framework for analysis of the term structure in which these differences disappear and i test its accuracy in practice using data from the crsp government bond tapes in a well known article in this journal cox ingersoll and ross cir 4 reexamine and find wanting certain hypotheses about the term structure of interest rates a striking feature of cir s re examination is that it is entirely theoretical cir show that different versions of the pure expectations theory of the term structure which traditionally were regarded as equivalent are in fact inconsistent with one another when interest rates are random furthermore in a fairly general continuous time arbitrage pricing framework when interest rates are random all versions of the theory except one are incompatible with equilibrium at first sight cir s results appear to be devastating to traditional empirical work on the term structure they suggest that researchers must specify arbitrage pricing models with a small number of state variables before proceeding to empirical work such models must restrict not only the deterministic components

time variation in term premia international survey based evidence using a large previously unexplored data set of survey based interest rate forecasts that covers a broad range of countries this paper re examines the expectations hypothesis of the term structure of interest rates we find that survey based interest rate forecasts outperform not only a random walk forecast but also outperform forecasts from forward rates when using these superior survey based forecasts in a modified expectations hypothesis test the expectations hypothesis is rejected for fewer countries at lower significance levels and has greater explanatory power than when using a traditional forward rates based test we furthermore document strong time variation in the term premia which is an important reason why the traditional expectations hypothesis test is rejected so frequently this time variation seems to arise from the changing attitudes towards risk among market participants and as a compensation for the change in liquidity in the term structure finally we find that generalizing findings from earlier u s studies to other countries may lead to bias in the true economic relationships in these countries

quality option profits switching option profits and variation margin costs an evaluation of their size and impact on treasury bond futures prices this paper provides empirical evidenee that the quality option in f bond futures is much less valuable than previously indicated in addition a dynamic trading strategy involving multiple switches of the cash bonds held in a long cash versus short futures position is shown to produce substantially greater profits than the single exercise of the quality op tion these findings suggest that the optimal management of long cash short futures positions is likely to involve dynamic trading strategies while passive strategies appear more appropriate for short cash long futures positions it is also shown that required variation margin payments are frequently large and may impact the profitability and risk of such positions to a greater extent than either of these options further evidenee is given indicating that observed t bond futures prices reflect an imputed value for the options and risks inherent in such positions

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

real and nominal interest rates under uncertainty the fisher theorem and the term structure this paper examines the relation between nominal and real interest rates and the nominal and real term structure under uncertainty we show that two separate risk terms cause the fisher theorem to fail one risk term is related only to the variability of money prices while the other is related to the purchasing power riskiness of the nominal bond monetary policy can affect the value of both these risk terms we also show that the pure expectations hypothesis of the term structure fails for both real and nominal bonds because of risk premia even if the economy is neutral with respect to monetary policy monetary policy can alter the nominal term structure

why haven t nominal rates declined the capital asset pricing model can be used to help explain the seemingly anomalous behavior of interest rates over the past several years specifically an examination of the covariances between the market returns and real unexpected rates of return on stocks bills and bonds of various durations indicates that the variance of return on longer term bonds increased appreciably between 1977 79 and 1980 81 while their correlations with stock returns rose the relative risk premiums on these bonds should have risen accordingly the calculated real risk premium on bonds of eight years duration did increase significantly between june 1979 and december 1981 it is entirely possible that this increase more than offset any decline in the long term expected inflation rate although risk alone cannot account for the increase in the real short term rate the timing of the increase suggests a possible correlation with the change in the federal reserve s operating procedures in october 1979 the puzzle of the flat nominal yield curve in the early 1980s may not be a puzzle at all

on the expectations view of the term structure term premia and survey based expectations in this paper uk disaggregate survey data of expected future interest rates are used to test the expectations model of the term structure of interest rates at the short end of the maturity spectrum in the aggregate the expectations model is rejected and both time varying term premia and expected interest rate changes are demonstrated to be important in explaining the slope of the yield curve within the aggregate data however we demonstrate that there are some differences with respect to the views of the term structure held for example for some individuals the pure expectations model cannot be rejected

on the perils of financial intermediaries setting security prices the mutual fund wild card option economic distortions can arise when financial claims trade at prices set by an intermediary rather than direct negotiation between principals we demonstrate the problem in a specific context the exchange of open end mutual fund shares mutual funds typically set fund share price nav using an algorithm that fails to account for nonsynchronous trading in the fund s underlying securities this results in predictable changes in nav which lead to exploitable trading opportunities a modification to the pricing algorithm that corrects for nonsynchronous trading eliminates much of the predictability however there are many other potential sources of distortion when intermediaries set prices copyright the american finance association 2001

understanding real interest rates this paper outlines an approach to measuring real interest rates and testing hypotheses on their behavior it then describes what we know about real interest rates in the aggregate economy and provides estimates of real interest rates for the agricultural sector the evidence presented in this paper indicates that real interest rates for the agricultural economy have been extremely high in the l98ds and that their behavior seems to be linked to that found for real rates in the aggregate economy what has been the source of these high real rates the answer seems to be that it was a result of a concerted effort by the monetary authorities to disinflate the economy however the brunt of the fed s disinflationary policy has fallen more heavily on the farm sector which has had to face far higher reel rates than the rest of the economy although breaking the back of inflation was certainly a worthy goal for the fed farmers have had to pay a heavy price they have had to suffer for the sins of an economy that was excessively inflationary which then had to be brought back into line with disinflationary policy this abstract was borrowed from another version of this item

do forecast errors or term premia really make the difference between long and short rates abstract forward rates in the term structure of interest contain predictions of future spot rates plus possibly term premia realized spot rates contain predicted spot rates plus forecast errors under rational expectations forecast errors are not predictable by forecasting spot rates using publicly available information bounds on the variation of forecast errors and term premia are obtained for one month treasury bill rates one to two thirds of the variation in the difference between forward rates and realized spot rates is due to variation in term premia

heterogeneous information and the theory of the business cycle the inability to observe the money supply and price level has been an essential ingredient of informational based equilibrium models of cycles here we assume these data are available but show that heterogeneous information about the productivity of capital can lead to a monetary theory of fluctuations in equilibrium each agent s investment depends on the difference between his own productivity and the perceived real rate in the presence of money demand shocks the nominal rate is noisy signal of the real rate this leads to greater fluctuations in output than if all agents had the same information

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

new techniques to extract market expectations from financial instruments this paper is a selective survey of new or recent methods to extract information about market expectations from asset prices for monetary policy purposes traditionally interest rates and forward exchange rates have been used to extract expected means of future interest rates exchange rates and inflation more recently these methods have been refined to rely on implied forward interest rates so as to extract expected future time paths very recently methods have been designed to extract not only the means but the whole risk neutral probability distribution from a set of option prices

the behavior of u s short term interest rates since october 1979 short term interest rates in the united states have been too high since october 1979 in the sense that both unconditional and conditional forecasts based on an estimated vector autoregression model summarizing the prior experience under predict short term interest rates during this period although a non structural model cannot directly answer the question of why this has been so comparisons of alternative conditional forecasts point to the post october 1979 relationship between the growth of real income and the growth of real money balances as closely connected to the level and pattern of short term interestrates this finding is consistent with the authors earlier conclusion based on analysis of a small structural macroeconometric model that the high average level of interest rates has been due to a combination of slow growth of nominal money supply and continuing price inflation which together have kept real balances small in relation to prevailing levels of economic activity this abstract was borrowed from another version of this item

export flexibility and currency hedging this article studies the behavior of an export flexible firm under exchange rate uncertainty we show that the separation theorem holds if selling exclusively in the domestic market is suboptimal even under the most unfavorable spot exchange rate otherwise the firm s optimal output depends on its preferences and on the underlying uncertainty we further show that the full hedging theorem holds only when the firm always finds it optimal to sell its entire output in the foreign market otherwise export flexibility introduces a convexity into the firm s foreign exchange risk exposure which calls for the use of currency options for hedging purposes

blue chip rationality tests this paper tests the rationality of forecasts made by individuals who contribute to the blue chip consensus forecasting service and tries by means of a questionnaire on forecasting methods to establish why some forecasters appear more rational than others tests based on consensus forecasts prove unreliable as guides to the number of individuals who produce rational forecasts individual forecasts are more likely to be rational if they are based on a mainstream economic theory and incorporate a substantial element of judgment copyright 1991 by ohio state university press

from cradle to grave how to loot a 401 k plan abstract the regulations governing asset distributions from many retirement plans give participants the option to time retirement or rollovers from the plan strategically they possess a long lived put option whose exercise price resets periodically to the current value of the assets in the plan i derive a recursive closed form valuation formula for the option and develop a numerical algorithm for implementing the result i find that for reasonable assumptions about volatility and life expectancy the option s value may approach 40 of the value of the assets in the plan financed entirely by those still contributing this wealth transfer can however be easily avoided by making a simple change to the current regulations governing valuation and payout of these retirement plans