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

can unspanned stochastic volatility models explain the cross section of bond volatilities in fixed income markets volatility is unspanned if volatility risk cannot be hedged with bonds we first show that all affine term structure models with state space m n m can be drift normalized and show when the standard variance normalization can be obtained using this normalization we find conditions for a wide class of affine term structure models to exhibit unspanned stochastic volatility usv we show that the usv conditions restrict both the mean reversions of risk factors and the cross section of conditional yield volatilities the restrictions imply that previously studied affine usv models are unlikely to be able to generate the observed cross section of yield volatilities however more general usv models can match the cross section of bond volatilities this paper was accepted by wei xiong finance

the use of eminent domain in land assembly the case of the tennessee valley authority eminent domain gives public agencies the right to acquire property from private individuals in exchange for just compensation following kelo vs new london 2005 the powers of eminent domain were extended opening the door for potential abuses of power by government officials in this paper i empirically investigate the use of eminent domain using newly digitized records from the tennessee valley authority tva which extensively used eminent domain to construct dams in the 1930s using a sample of families living in one reservoir location i find empirical evidence that land tenure the number of property holdings and debt levels affected the holdout decision suggesting that holdouts are individuals with high subjective values i then develop a screening model with asymmetric information in seller valuations to predict when eminent domain will be used and what settlement values and court awards would be i test the model s and find that individuals who held out increased their property value by about 5 and incentives to holdout existed only for individuals who received initially low settlement proposals

explaining and forecasting bond risk premiums in examining the risk premiums for u s and german 10 year government bond yields the authors found that the decline in bond risk premiums since the 1980s is associated with a decrease in global output variability and an increase in the power of 10 year government bonds to diversify portfolios

a joint model for the term structure of interest rates and the macroeconomy we present and estimate a continuous time term structure model that incorporates observable macroeconomic variables and latent variables with a clear macroeconomic interpretation our model is able to accurately describe the joint dynamics for us macroeconomic variables and the yield curve however the observable variables do not explain the long end of the term structure central tendencies of these macroeconomic variables do a much better job in this respect these unobservable factors also play an important role in the description of the interest rate policy rule both observable and non observable factors determine the risk premia and hence bond excess holding returns copyright 2006 john wiley sons ltd

no arbitrage taylor rules with switching regimes we study the time varying nature of u s monetary policies summarized by the taylor rule based on a continuous time regime switching term structure model in this model the spot rate follows the taylor rule and government bonds at different maturities are priced by no arbitrage we allow the coefficients of the taylor rule and the dynamics of inflation and output gap to be regime dependent and estimate the model using government bond yields we find that the fed is proactive in controlling inflation in one regime and accommodative for growth in another moreover proactive monetary policies are associated with more stable inflation and output gap and therefore could have contributed to the great moderation our analysis also highlights the importance of switching regimes for term structure modeling without the regimes inflation and output can explain less than 50 of the variations of bond yields with the regimes the two variables can explain more than 80 of the variations of bond yields

term premiums in bond returns abstract this paper examines expected returns on u s treasury bills and on u s government bond portfolios expected bill returns are estimated from forward rates and from sample average returns both estimation methods indicate that expected returns on bills tend to peak at eight or nine months and never increase monotonically out to twelve months reliable inferences are limited to treasury bills and thus to maturities up to a year the variability of longer term bond returns preempts precise conclusions about their expected returns

testing the expectations hypothesis using long maturity forward rates abstract this paper reports on long maturity interest rates the results hardly vary across maturities using forward rate regressions the expectations hypothesis eh is numerically close to being accepted for a long short data set the eh is statistically rejected accepted

land quality and prices although land values reflect land quality the quality characteristics that determine values are only partly related to agricultural uses the results of estimating a reduced form equation explaining differences in land prices among states suggest that nearly two thirds of this variation is attributed to nonagricultural uses therefore a land quality index based on raw land prices will be biased which in turn will result in biased coefficients in a production function or its dual a cross section land quality index which excludes the influence of nonagricultural uses is constructed the main purpose of this paper is to construct a state level cross section land quality index for land used in agricultural pursuits the index is designed to adjust the land input for quality differences among states in aggregate agricultural production functions or short run profit or cost functions where land is held constant the weights employed to construct the index can also be used to construct a quality constant land price index for use in long run agricultural profit or cost functions having land price as an argument

from bond yield to macroeconomic instability a parsimonious affine model abstract we present a hybrid heston model with a common stochastic volatility to describe government bond yield dynamics the model is analytically tractable and therefore can be efficiently estimated using the maximum likelihood approach and a specific expansion in order to cope with the curse of dimensionality twofold is the model contribution first it captures changes in the yield volatility and predict future yield values of germany french italy and spain the result is an early warning indicator which anticipates phases of instability characterizing the time series investigated then the model describes convergence divergence phenomena among european government bond yields and explores the countries reactions to a common monetary policy described through the eonia interbank rate we also investigate the potential of this indicator on u s data treasury bills

evaluating an alternative risk preference in affine term structure models dai and singleton 2002 and duffee 2002 show that there is a tension in affine term structure models between matching the mean and the volatility of interest rates this article examines whether this tension can be solved by an alternative parametrization of the price of risk the empirical evidence suggests that first the examined parametrization is not sufficient to solve the mean volatility tension second the usual result in the estimation of affine models indicating that some of the state variables are extremely persistent may have been caused by the lack of flexibility in the parametrization of the price of risk term structure models have several uses including pricing fixed income derivatives managing the risk of fixed income portfolios and detecting relationships between the term structure of interest rates and macrovariables such as inflation and consumption to perform well in these tasks term structure models must be numerically and econometrically tractable while matching the empirical properties of the term structure movements at least two empirical properties of the term structure of interest rates have been well established by financial economists over the years see dai and singleton 2003 for a survey first the term premium or the expected excess return of treasury bonds has a high time variability second the volatility of interest rates is time varying these two properties are so prominent in the data that they will be referred to as stylized facts while these two stylized facts are very well established in the empirical literature affine term structure models are thoroughly discussed in the theoretical literature affine models are those in which the yield of zero coupon bonds are affine functions of the model state variables classic

the term structure of interest rates with housing abstract this paper develops a general equilibrium model to study the link between the amount of capital invested in housing assets and the term structure of interest rates in the model the production of housing assets is irreversible and housing assets can be used as collateral for borrowing funds agents decisions about consumption and investments in housing and non housing assets generate a time varying market price of risk that drives the dynamics of the term structure the calibration to u s data using the simulated method of moments technique captures the dynamics of consumption and the short and long term interest rates

interest rate volatility the yield curve and the macroeconomy abstract this paper provides theory and evidence that a low dimensional term structure model can simultaneously price bonds and related options it shows that a component of volatility risk largely unrelated to the shape of the yield curve is a determinant of expected excess returns for holding long maturity bonds it also finds evidence for this return relationship both in the model and directly in the data through regression analysis the paper also identifies a link between corporate earnings performance and interest rate volatility providing a channel driving interest rate volatility the structure of risk in the model that gives rise to these features of volatility is distinct from that inherent in recent models with unspanned stochastic volatility

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

land prices land rents and technological change evidence from pakistan abstract the intertemporal behavior of land prices and land rents in two production environments of pakistan is investigated empirical analyses indicate that a agricultural technology adoption has had a strong positive impact on real land rents over the past 30 years in both irrigated and rainfed areas b capitalization of rents into land prices has accounted for approximately 70 of observed increases in land prices during this period c expected capital gains have been an important additional factor driving up land prices and d neither expected inflation nor inflows of remittance income from abroad have had a significant effect on land prices

factors determining differences in local hunting lease rates insights from blinder oaxaca decomposition factors determining local hunting lease rates and differences between rates across mississippi regions were analyzed using blinder oaxaca decomposition procedures per acre rates were 26 greater in west versus east mississippi depending on the decomposition procedure employed differences in resource endowments accounted for 43 to 69 of the gap differences in habitat quality were primarily responsible lessors in east mississippi can improve their rates by reducing lease sizes and shortening contract lengths information about differences in local lease rates and the sources of those differences is critically needed by landowners outfitters hunters financial institutions and natural resource managers

regime shifts in a dynamic term structure model of u s treasury bond yields this article develops and empirically implements an arbitrage free dynamic term structure model with priced factor and regime shift risks the risk factors are assumed to follow a discrete time gaussian process and regime shifts are governed by a discrete time markov process with state dependent transition probabilities this model gives closed form solutions for zero coupon bond prices an analytic representation of the likelihood function for bond yields and a natural decomposition of expected excess returns to components corresponding to regime shift and factor risks using monthly data on u s treasury zero coupon bond yields we show a critical role of priced state dependent regime shift risks in capturing the time variations in expected excess returns and document notable differences in the behaviors of the factor risk component of the expected returns across high and low volatility regimes additionally the state dependence of the regime switching probabilities is shown to capture an interesting asymmetry in the cyclical behavior of interest rates the shapes of the term structure of volatility of bond yield changes are also very different across regimes with the well known hump being largely a low volatility regime phenomenon jel g12 this article develops and empirically implements an arbitrage free dynamic term structure model dtsm with priced factor and regimeshift risks the risk factors are assumed to follow a discrete time gaussian process and regime shifts are governed by a discrete time markov process with state dependent transition probabilities agents are assumed to know both the current state of the economy and the regime they are currently in this leads to regime dependent risk neutral pricing and an equilibrium term structure that reflects the risks of both changes in the state and shifts in regimes

modeling sovereign yield spreads a case study of russian debt we construct a model for pricing sovereign debt that accounts for the risks of both default and restructuring and allows for compensation for illiquidity using a new and relatively efficient method we estimate the model using russian dollar denominated bonds we consider the determinants of the russian yield spread the yield differential across different russian bonds and the implications for market integration relative liquidity relative expected recovery rates and implied expectations of different default scenarios this paper develops a model of the termstructure of credit spreads on sovereign bonds that accommodates i default or repudiation the sovereign announces that it will stop making payments on its debt ii restructuring or renegotiation the sovereign and the lenders agree to reduce or postpone the remaining payments and iii a regime switch such as a change of government or the default of another sovereign bond that changes the perceived risk of future defaults we build on the framework of duffie and singleton 1999 showing that cash flows promised by a sovereign bond can be discounted using a default adjusted short termdiscount rate that reflects the m ean arrival rate and associated losses in market value upon arrival of each of the aforementioned types of credit events since a sovereign credit event is often not a liquidation event the model allows for continued trading and pricing of a sovereign instrument through credit events possibly after writedowns in face value or cash distributions to creditors on credit event dates additionally we accommodate the possibility that bonds issued by the same sovereign of exactly the same type but possibly of different maturities may be priced in the market using different discount factors reasons for this may include i bond covenants may not include cross default clauses that would force upon the default of one bond the simultaneous default of other bonds of the same type but of a different maturity for various strategic reasons related to internal

expectation puzzles time varying risk premia and dynamic models of the term structure abstract linear projections of returns on the slope of the yield curve have contradicted the implications of the traditional expectations theory this paper shows that these findings are not puzzling relative to a large class of richer dynamic term structure models specifically we match all the key empirical findings reported by fama and bliss 1987 american economic review 77 4 680 692 and campbell and shiller 1991 review of economic studies 58 495 514 among others within large subclasses of affine and quadratic gaussian term structure models additionally we show that certain risk premium adjusted projections of changes in yields on the slope of the yield curve recover the coefficients of unity predicted by the models key to this matching are parameterizations of the market prices of risk that let the risk factors affect the market prices of risk directly and not only through factor volatilities the risk premiums have a simple form consistent with fama s findings on the predictability of forward rates and are also shown to be consistent with interest rate feedback rules used by a monetary authority in setting monetary policy

monetary policy bond returns and debt dynamics abstract using the government s intertemporal budget constraint we quantify the contribution of returns paid on the u s government s debt portfolio to the evolution of the debt to gdp ratio we show that announcements of unconventional monetary policy measures by the federal reserve between 2008 iv and 2012 as a part of macroeconomic stabilization were associated with a sizable increase in returns and debt to gdp ratios and contributed to fiscal imbalances we use the federal reserve s portfolio composition as a proxy for unconventional monetary policy measures and show that it is significantly related to future bond returns and fiscal balances

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

unspanned stochastic volatility in affine models evidence from eurodollar futures and options unspanned stochastic volatility usv refers to the inability of bonds to replicate volatility sensitive derivative securities affine term structure models require special restrictions on the parameters to exhibit usv we use a joint eurodollar futures and options data set to estimate affine three factor models with and without usv restrictions the unrestricted model captures prices of futures and options well option pricing errors are much larger in the usv model the usv model is rejected in favor of the unrestricted model based on the likelihood ratio and wald tests we use the implications of the unrestricted model as a benchmark for understanding the extant evidence that favors usv specifically we replicate extant tests in samples simulated from the unrestricted model we show that none of the existing findings contradict the model without usv restrictions

endogenous term premia and anomalies in the term structure of interest rates explaining the predictability smile abstract numerous studies have documented a predictability smile in the post war term structure of interest rates spreads between long rates and short rates predict subsequent movements in short rates provided the long horizon is less than three months or greater than two years but not for intermediate maturities proposed explanations of the smile involve interest rate smoothing by the fed time varying risk premia peso problems and measurement error we show that despite their highly restrictive nature some parameterizations of the cox ingersoll ross cir and chen scott cs models of the term structure can account for the predictability smile cir and cs parameterizations which are consistent with the smile regularity are inconsistent with other features of the data however

work incentives in the afdc system an analysis of the 1981 reforms the road to welfare reform increasingly appears to be one of the rockier paths the united states has traversed indeed by all outward appearances it is not even clear whether the current path runs uphill or downhill as far as work incentives in the welfare system are concerned economists of all political persuasions from milton friedman to james tobin have agreed that the uphill direction is that which leads to lower tax rates i e lower benefit reduction rates however as with free trade the near unanimity of opinion among economists has strangely only occasionally persuaded a majority of the nation s representatives to vote to go uphill the legislative history so illustrates from 1935 when the aid to families with dependent children afdc program was enacted to the 1967 social security amendments the tax rate in the program was 100 percent that is benefits were reduced by one dollar for every extra dollar earned with the 1967 amendments congress lowered the tax rate to 67 percent and in the heady atmosphere of the 1960 s it was expected that further progress in this direction would be made and that the tax rate would be lowered further indeed the family assistance plan subsequently proposed by president nixon would have lowered tax rates however the legislation passed the house but not the senate the ford administration considered welfare reform proposals internally but never proposed legislation while the carter administration proposed a massive welfare reform plan that met with no legislative success welfare reform was finally achieved in 1981 when the omnibus budget reconciliation act obra was enacted but obra increased the tax rate back to 100 percent the level prevailing prior to 1967 in retrospect it appears that 1967 marked the end not the beginning of legislative progress on work incentives in the welfare system in this paper i shall report the results of recent research that complicates the issue considerably by questioning whether lower tax rates do in fact provide work incentives the findings themselves seesaw not unlike the path of welfare reform itself first on a theoretical basis it appears that lower tax rates in a welfare program do not necessarily increase labor supply in the low income population as a whole contrary to the conventional wisdom in fact it also appears that members of the reagan administration were aware of this all along well in advance of the economics profession this theoretical ambiguity has fairly fundamental implications for the work incentive issue in welfare reform second nevertheless the empirical resolution of the ambiguity provided by existing econometric estimates in the labor supply literature and by estimates of the effect of afdc on labor supply indicates that a lower tax rate would indeed increase labor supply in the low income population as a whole and that a higher tax rate would decrease it thus the conventional wisdom is correct even though based upon an incorrect tdiscussants henry aaron the brookings institution and university of maryland harold watts columbia university edward gramlich university of michigan

an international examination of affine term structure models and the expectations hypothesis we examine the yield curve behavior and the relative performance of affine term structure models atsms using government bond yield data from canada germany japan the u k and the u s we find strong predictability of forward rates for excess bond returns and reject the expectations hypothesis in all five countries a three factor model is sufficient to capture movements in the yield curve of canada japan the u k and the u s but may not be enough for germany an exhaustive comparison among atsms with no more than three factors reveals that the three factor essential affine model a 1 3 e with only one factor affecting the volatility of the short rate but with all three factors affecting the price of risk performs best in all five countries simulations provide inconclusive evidence on whether this best affine model can successfully generate the rich yield curve behavior observed in the data

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