consumption and debt response to unanticipated income shocks evidence from a natural experiment in singapore abstract this paper uses a unique panel dataset of consumer financial transactions to study how consumers respond to an exogenous unanticipated income shock consumption rose significantly after th

swap rates and credit quality this article presents a model for valuing claims subject to default by both contracting parties such as swaps and forwards with counterparties of different default risk the promised cash flows of a swap are discounted by a switching discount rate that at any given state and time is equal to the discount rate of the counterparty for whom the swap is currently out of the money that is a liability the impact of credit risk asymmetry and of netting is presented through both theory and numerical examples which include interest rate and currency swaps this article presents a model for valuing claims subject to default by both contracting parties such as swaps and forwards this extends the valuation model for defaultable claims proposed by duffie and singleton 1994 to cases in which the two counterparties have asymmetric default risk the extension permits a reexamination of the impact of credit risk on swap rates while the valuation model applies to all forms of contingent claims in which both contracting parties are at risk to default such as forward contracts we focus on swaps for purposes of illustration for example consider a 5 year interest rate swap between a given party paying a floating rate such as the london inter bank offered rate libor and another counterparty paying a fixed rate replacing the given fixed rate counterparty with a lower quality counterparty whose bond yields are 100 basis points higher increases the swap rate by roughly 1 basis point using our model and typical parameters for libor rate processes this credit impact on swap rates is approximately linear within the range of normally encountered credit quality for a 5 year currency swap given a foreign exchange rate with 15 percent volatility our model shows the impact of credit risk asymmetry on the market swap rate to be roughly 10 fold greater than that for interest rate swaps that is approximately 10 basis points in swap rate per 100 basis points in bond yield credit spread the main goal of this article is to provide a simple and theoretically consistent model allowing such computations

explaining european union citizens trust in the european central bank in normal and crisis times we study the determinants of trust in the european central bank ecb as measured by the european commission s eurobarometer survey in particular during the global financial crisis and the european sovereign debt crisis we find that the fall in trust in the ecb in crisis times can be rather well explained based on the pre crisis determinants we also show that the fall in trust reflected the macroeconomic deterioration a more generalized fall in the trust in european institutions in the wake of the crisis and the severity of the banking sector s problems to which the ecb was associated in the public opinion

terms of trade shocks and the balance of trade there is a harberger laursen metzler effect abstract according to the harberger laursen metzler hlm effect an exogenous increase in the terms of trade faced by a small open economy leads to an improvement in that country s trade balance in this paper structural vector autoregression techniques are used to investigate whether there is any systematic pattern in the responses of the trade balance to terms of trade shocks for a large number of small open economies two important results emerge first there is strong support in the data for the existence of an hlm effect second the response of the trade balance and real income to a terms of trade shock implied by the structural vector autoregression model are strongly consistent with those reported by mendoza 1995 from simulating a particular dynamic stochastic equilibrium model of a small open economy

would helicopter money be spent new evidence for the netherlands according to some economists central banks should use helicopter money to boost inflation expectations based on a survey among dutch households we examine whether respondents would spend the

necessity as the mother of invention monetary policy after the crisis we examine recent changes in monetary policy due to the financial crisis and ask whether they are likely to be temporary or permanent we present evidence from two original surveys one of central bank governors the other of academic specialists we find that central banks in crisis countries are more likely to have resorted to new policies to have had discussions about changing mandates and to have communicated more extensively but thinking has changed more broadly for instance many central banks in non crisis countries also report implementing macro prudential measures looking forward we expect central banks to have broader mandates use macro prudential tools more widely and communicate more actively than before the crisis while there is no consensus yet about the usefulness of unconventional monetary policies we expect most of them will remain in central banks toolkits as governors who gain experience with a particular tool are more likely to assess that tool positively finally the relationship between central banks and their governments might well have changed with central banks crossing the line into the political realm more often than in the past

energy consumption real income and temporal causality results from a multi country study based on cointegration and error correction modelling techniques abstract unlike previous studies on the causal relationship between energy consumption and economic growth this paper illustrates how the finding of cointegration i e long term equilibrium relationship between these variables may be used in testing granger causality based on the most recent johansen s multivariate cointegration tests preceded by various unit root or non stationarity tests we test for cointegration between total energy consumption and real income of six asian economies india pakistan malaysia singapore indonesia and the philippines non rejection of cointegration between variables rules out granger non causality and imples at least one way of granger causality either unidirectional or bidirectionial secondly by using a dynamic vector error correction model we then analyse the direction of granger causation and hence the within sample granger exogeneity or endogeneity of each of the variables thirdly the relative strength of the causality is gauged through the dynamic variance decomposition technique by decomposing the total impact of an unanticipated shock to each of the variables beyond the sample period into proportions attributable to shocks in the other variables including its own in the bivariate system results based on these tools of methodology indicate that while all pair wise relationships shared common univariate integrational properties only relationships for three countries india pakistan and indonesia were cointegrated for these countries temporal causality results were mixed with unidirectional causality from energy to income for india exactly the reverse for indonesia and mutual causality for pakistan the vdcs were not inconsistent with these results and provided us with an additional insight as to the relatively more dominant direction of causation in pakistan simple bivariate vector autoregressive models for the three non cointegrated systems did not indicate any direction of causality significantly in either direction

bond pricing and the term structure of interest rates a new methodology for contingent claims valuation this paper presents a unifying theory for valuing contingent claims under a stochastic term structure of interest rates the methodology based on the equivalent martingale measure technique takes as given an initial forward rate curve and a family of potential stochastic processee for its subsequent movements a no arbitrage condition restricts this family of processes yielding valuation formulae for interest rate sensitive contingent claims which do not explicitly depend on the market prices of risk examples are provided to illustrate the key results in relation to the term structure of interest rates arbitrage pricing theory has two purposes the first is to price all zero coupon default free bonds of varying maturities from a finite number of economic fundamentals called state variables the second is to price all interest rate sensitive contingent claims taking as given the prices of the zero coupon bonds this paper presents a general theory and a unifying framework for understanding arbitrage pricing theory in this context of which all existing arbitrage pricing models are special cases in particular vasicek 1977 brennan and schwartz 1979 langetieg 1980 ball and torous 1983 ho and lee 1986 schaefer and schwartz 1987 and artzner and delbaen 1988 the primary contribution of this paper however is a new methodology for solving the second problem i e the pricing of interest rate sensitive contingent claims given the prices of all zero coupon bonds the methodology is new because i it imposes its stochastic structure directly on the evolution of the forward rate curve ii it does not require an inversion of the term structure to eliminate the market prices of risk from contingent claim values and iii it has a stochastic spot rate process with multiple stochastic factors influencing the term structure the model can be used to consistently price and hedge all contingent claims american or european on the term structure and it is derived from necessary and more importantly sufficient conditions for the absence of arbitrage the arbitrage pricing models of vasicek 1977 brennan and schwartz 1979 langetieg 1980 and artzner and delbaen 1988 all require an iformerly titled bond pricing and the term structure of interest rates a new methodology

stock market expectations of dutch households despite its importance for the analysis of life cycle behavior and in particular retirement planning stock ownership by private households is poorly understood among other approaches to investigate this puzzle recent research has started to elicit private households expectations of stock market returns this paper reports findings from a study that collected data over a two year period both on households stock market expectations subjective probabilities of gains or losses and on whether they own stocks we document substantial heterogeneity in financial market expectations expectations are correlated with stock ownership over the two years of our data stock market prices increased and expectations of future stock market price changes also increased lending support to the view that expectations are influenced by recent stock gains or losses

consumer spending and the economic stimulus payments of 2008 abstract we measure the change in household spending caused by receipt of the economic stimulus payments of 2008 using questions added to the consumer expenditure survey and variation from the ran

trust me i am a european central banker in the aftermath of the financial crisis the ecb has experienced an unprecedented deterioration in the level of trust this raises the question as to what factors determine trust in central banking we use a unique cross country dataset which includes a rich set of socioeconomic characteristics and supplement it with variables meant to reflect a country s macroeconomic condition we find that besides individual socio economic characteristics macroeconomic conditions play a crucial role in the trust building process our results suggest that agents are boundedly rational in the trust building process and that current ecb market operations may even be beneficial for trust in the ecb in the long run

trust no more the impact of the crisis on citizens trust in central banks abstract citizens trust in economic institutions has generally declined since the onset of the crisis in particular eurobarometer surveys show that trust in the european central bank ecb has fallen significantly during the crisis this paper studies the determinants of public trust in the ecb over the lifetime of the euro net trust in the ecb has decreased significantly in those countries which have experienced increasing sovereign bond yields and financial market turbulence the finding that country specific variables affect citizens trust in the ecb may seem counterintuitive however it is consistent with strong evidence in the political science literature showing that domestic considerations play a significant role when citizens get an opportunity to express their opinion on eu matters

household expenditure and the income tax rebates of 2001 using questions expressly added to the consumer expenditure survey we estimate the change in consumption expenditures caused by the 2001 federal income tax rebates and test the permanent income hypothesis we exploit the unique randomized timing of rebate receipt across households households spent 20 to 40 percent of their rebates on nondurable goods during the three month period in which their rebates arrived and roughly two thirds of their rebates cumulatively during this period and the subsequent three month period the implied effects on aggregate consumption demand are substantial consistent with liquidity constraints responses are larger for households with low liquid wealth or low income

noisy news and exchange rates a svar approach abstract this paper introduces noisy news shocks into a model of exchange rate determination to measure the impact of these shocks using a svar agents in the foreign exchange market make decisions with imperfect information about economic fundamentals driving interest rate differentials between countries in that they must rely on a noisy signal of future interest rates i apply the framework to the usd gbp nominal exchange rate for the period 1986 2013 results show that noisy news explains approximately one fifth of the forecast error variance in the nominal exchange rate with noise accounting for double 12 that of news 6 a historical decomposition of the exchange rate indicates that noise shocks are especially important during periods of changing monetary policy e g the 1990 easing and 2001 tightening of u s monetary policy and the unconventional monetary policies surrounding the financial crisis of 2008

exports investments and economic development of pre accession countries of the european union an empirical investigation of bulgaria and romania this paper attempts to analyse the relationship between exports investments and economic development in two pre accession countries of the european union bulgaria and romania for investigation of this relationship a multivariate autoregressive var model is used the results of cointegration analysis showed that there is one cointegrated vector among exports investments and economic growth for the two countries granger causality tests based on error correction models ecm indicated that there is a strong granger causal relation between economic growth and exports as well as between investments and exports for the two countries in addition economic development and capital accumulation in an economy seem to have just as much of an influence on exports as exports have on capital accumulation and economic development

common factors and local factors implications for term structures and exchange rates this paper studies a multi factor two country term structure and exchange rate model when a diversification effect for an international bond portfolio is expected it shows that the diversification gain calls upon certain restrictions on the process of the stochastic discount factor in a factor structured economy existence of local factors is shown to be a necessary condition for the gains from investing in foreign bonds further the exchange rate risk premia are shown to be a function of the differentials of the risk premia of the factors in bond returns empirical results reveal the tendency for investors to respond sensitively to rare shocks which is shown to be a potential solution to the forward premium puzzle

affine models of the joint dynamics of exchange rates and interest rates this paper extends the affine class of term structure models to describe the joint dynamics of exchange rates and interest rates in particular the issue of how to reconcile the low volatility of interest rates with the high volatility of exchange rates is addressed the in complete market approach of introducing exchange rate volatility that is orthogonal to both interest rates and the pricing kernels is shown to be infeasible in the affine setting models in which excess exchange rate volatility is orthogonal to interest rates but not orthogonal to the pricing kernels are proposed and validated via kalman filter estimation of maximal 5 factor models for 6 country pairs

inflation expectations and behavior do survey respondents act on their beliefs we compare the inflation expectations reported by consumers in a survey with their behavior in a financially incentivized investment experiment the survey is found to be informative in the sense that the beliefs reported by the respondents are correlated with their choices in the experiment more importantly we find evidence that most respondents act on their inflation expectations showing patterns consistent with economic theory respondents whose behavior cannot be rationalized tend to have lower education and lower numeracy and financial literacy these findings help confirm the relevance of inflation expectations surveys and provide support to the microfoundations of modern macroeconomic models

taxation and consumption evidence from a representative survey of the german population abstractusing a representative survey of the german population this article studies self reported individual consumption responses to a recent exogenous payroll tax reduction about 55 of the respondents report that they spend the extra money indicating considerable potential for tax changes to affect consumption and economic activity our analysis of the socio demographic and economic covariates of consumption responses suggests among other effects that interest rates are related to consumption responses to tax changes and that households with higher income have a higher propensity to consume

central bank communication and monetary policy a survey of theory and evidence over the last two decades communication has become an increasingly important aspect of monetary policy these real world developments have spawned a huge new scholarly literature on central bank communication mostly empirical and almost all of it written in this decade we survey this ever growing literature the evidence suggests that communication can be an important and powerful part of the central bank s toolkit since it has the ability to move financial markets to enhance the predictability of monetary policy decisions and potentially to help achieve central banks macroeconomic objectives however the large variation in communication strategies across central banks suggests that a consensus has yet to emerge on what constitutes an optimal communication strategy

the effects of lottery prizes on winners and their neighbors evidence from the dutch postcode lottery each week the dutch postcode lottery pcl randomly selects a postal code and distributes cash and a new bmw to lottery participants in that code we study the effects of these shocks on lottery winners and their neighbors consistent with the life cycle hypothesis the effects on winners consumption are largely confined to cars and other durables consistent with the theory of in kind transfers the vast majority of bmw winners liquidate their bmws we do however detect substantial social effects of lottery winnings pcl nonparticipants who live next door to winners have significantly higher levels of car consumption than other nonparticipants

mortgage risks debt literacy and financial advice a limited understanding of mortgage contracts and the risks involved may have contributed to the outbreak of the 2007 2008 financial crisis we developed a special questionnaire relating mortgage loan decisions to financial knowledge and financial advice our results demonstrate that homeowners appear to be well aware of mortgage risks large loans relative to home value are perceived as riskier as are loans with large mortgage payments relative to income and loans linked to investment vehicles homeowners with riskier mortgages indicated that they could encounter financial problems should house prices or their income decline homeowners with relatively low debt literacy are more likely to take out traditional mortgages with principal repayments over the maturity of the loan riskier mortgages are more prevalent among homeowners with a better understanding of loan contracts financially less sophisticated homeowners consulting mortgage brokers too hold riskier mortgages

macroeconomic fundamentals and the exchange rate dynamics a no arbitrage macro finance approach abstract in this paper we propose an arbitrage free international macro finance model that links the exchange rate dynamics to macroeconomic fundamentals jointly using data on exchange rates yields of zero coupon bonds and macroeconomic variables of the us and the euro area we find a close link between macroeconomic fundamentals and the exchange rate dynamics the model implied monthly exchange rate changes can explain about 57 variation of the observed data the macroeconomic innovations can help capture large variation of exchange rate changes robustness checks show that the results also hold for other major exchange rates

the economic importance of financial literacy theory and evidence this paper undertakes an assessment of a rapidly growing body of economic research on financial literacy we start with an overview of theoretical research which casts financial knowledge as a form of investment in human capital endogenizing financial knowledge has important implications for welfare as well as policies intended to enhance levels of financial knowledge in the larger population next we draw on recent surveys to establish how much or how little people know and identify the least financially savvy population subgroups this is followed by an examination of the impact of financial literacy on economic decision making in the united states and elsewhere while the literature is still young conclusions may be drawn about the effects and consequences of financial illiteracy and what works to remedy these gaps a final section offers thoughts on what remains to be learned if researchers are to better inform theoretical and empirical models as well as public policy jel a20 d14 g11 i20 j26

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

the effects of budget deficit on national saving in the oecd abstract in this paper we estimate a structural var using a panel of oecd countries which includes national saving and budget deficit both as the ratio to gdp to test the ricardian equivalence hypothesis in this framework we separate saving and deficit movements into two types of shocks associated with structural parameters of these economies our results suggest that ricardian equivalence did not work in our sample of oecd countries since private saving compensated only a small fraction budget deficit this supports the interpretation that the large budget deficits have been a very important factor behind the significant increase in real interest rates in the eighties and early nineties

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

the effects of a money financed fiscal stimulus abstract i analyze the effects of a money financed fiscal stimulus and compare them with those resulting from a conventional debt financed stimulus i study the effects of both a tax cut and an increase in government purchases with and without a binding zero lower bound zlb on the nominal interest rate when the zlb is not binding a money financed fiscal stimulus is shown to have much larger multipliers than a debt financed fiscal stimulus that difference in effectiveness persists but is much smaller under a binding zlb nominal rigidities are shown to play a major role in shaping those effects

wealth shocks unemployment shocks and consumption in the wake of the great recession we use data from the 2009 internet survey of the health and retirement study to examine the consumption impact of wealth shocks and unemployment during the great recession in the us we find that many households experienced large capital losses in housing and in their financial portfolios and that a non trivial fraction of respondents have lost their job as a consequence of these shocks many households reduced substantially their expenditures we estimate that the marginal propensities to consume with respect to housing and financial wealth are 1 and 3 3 percentage points respectively in addition those who became unemployed reduced spending by 10 percent we also distinguish the effect of perceived transitory and permanent wealth shocks splitting the sample between households who think that the stock market is likely to recover in a year s time and those who don t in line with the predictions of standard models of intertemporal choice we find that the latter group adjusted much more than the former its spending in response to financial wealth shocks

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

demand and supply shocks in italy an application to industrial output abstract we investigate the impact of three different kinds of disturbances on industrial output in italy they originate respectively in aggregate demand technology and the labour supply we first illustrate the theoretical restrictions which permit identification of the three shocks then econometric identification is achieved by extending the blanchard and quah 1989 the american economic review 79 pp 655 673 procedure to a multivariate case our main conclusion is that output variability is significantly affected by technological shocks at all frequencies labour supply disturbances are also relevant while demand shocks have a minor impact on the series although they act in the expected direction therefore the short run behaviour of industrial production is largely explained by supply side shocks

international capital markets and foreign exchange risk author s brennan michael j xia yihong abstract the relation between the volatilities of pricing kernels associated with di erent currencies and the volatility of the exchange rate between the currencies is derived under the assumption of integrated capital markets and the volatilities of the pricing kernels are related to the foreign exchange risk premium time series of pricing kernel volatilities are estimated from panel data on bond yields for five major currencies using a parsimonious term structure model that allows for time varying pricing kernel volatilities the resulting estimates are used to test hypotheses about the relation between the volatilities of the pricing kernels in di erent currencies and the volatility of the exchange rate as predicted time variation in foreign exchange risk premia is found to be related to time variation in both the volatility of the pricing kernels and the volatility of exchange rates the estimated pricing kernel volatilities can account for the forward premium puzzle in an average sense across exchange rates

on the asset market view of exchange rates if the asset market is complete then the difference between foreign and domestic agents log intertemporal marginal rates of substitution imrss equals the log change in the real exchange rate this equation is frequently used to argue that changes in real exchange rates reflect differences between agents required compensation for exposure to asset return uncertainty we show that the relative returns on frictionlessly traded assets are only reflected in the common component of agents imrss not in differences instead when this equation does offer insights frictions in the goods market are the source of economic distinction between agents

the time variation of expected returns and volatility in foreign exchange markets this article analyzes the time variation in conditional means and variances of monthly and quarterly excess dollar returns on eurocurrency investments all results are based on a vector autoregression with weekly sampled data on exchange rate changes and forward premiums of three currencies both past exchange rate changes and forward premiums predict future forward market returns moreover past forward premium volatilities predict the volatility of exchange rates expected forward market returns are very variable and persistent and exhibit marked comovements these results carry over to cross rate e g yen mark investments as well

the effects of domestic and foreign yield curves on the value of currency american call options this paper examines the sensitivity of the values of foreign currency american call options to the domestic and foreign term structures of interest rates pricing performances of currency option models are compared with and without the term structure effects it is shown that there exist significant pricing biases if flat yield curves are assumed and that different shapes of domestic and foreign yield curves can have major impacts on currency option prices

the effects of macroeconomic shocks on sector specific returns the reliance on market and sector specific indexes to evaluate managed portfolios and the popularity of index investing has increased the importance of understanding what leads to market movements how long they may last and how different sectors respond to macroeconomic shocks this research is concerned with how shocks to macroeconomic variables affect five major s p sector specific stock market indexes the paper employs the newly developed econometric technique of generalized impulse response analysis the results identify the various responses of the sectors to unanticipated changes in some key macroeconomic variables asset prices are commonly believed to react sensitively to economic news daily experience seems to support the view that individual asset prices are influenced by a wide variety of unanticipated events and that some events have a more pervasive effect on asset prices than do others chen et al 1986 p 386

helicopter money in europe new evidence on the marginal propensity to consume across european households the recent spread of covid 19 has led to the worst economic crisis since the 1930s to boost demand after the crisis direct monetary transfers to households are being discussed using novel microdata from the eurosystem household finance and consumption survey hfcs we study how much of such a transfer households would actually spend we do so by exploiting the unique opportunity that the new wave of the survey included an experimental question to calculate the marginal propensity to consume from hypothetical windfall gains our results show that households on average spend between about 33 the netherlands and 57 lithuania of such a transfer in all countries answers are clustered at spending nothing spending 50 and spending everything marginal propensities to consume decrease with income but are not as clearly related to wealth

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

the effects of subjective survival on retirement and social security claiming according to the life cycle model mortality risk will influence both retirement and the desire to annuitize wealth we estimate the effect of subjective survival probabilities on retirement and on the claiming of social security benefits because delayed claiming is equivalent to the purchase of additional social security annuities we find that those with very low subjective probabilities of survival retire earlier and claim earlier than those with higher subjective probabilities but the effects are not large the great majority of workers claim as soon as they are eligible copyright 2004 john wiley sons ltd

simulated likelihood estimation of diffusions with an application to exchange rate dynamics in incomplete markets abstract we present an econometric method for estimating the parameters of a diffusion model from discretely sampled data the estimator is transparent adaptive and inherits the asymptotic properties of the generally unattainable maximum likelihood estimator we use this method to estimate a new continuous time model of the joint dynamics of interest rates in two countries and the exchange rate between the two currencies the model allows financial markets to be incomplete and specifies the degree of incompleteness as a stochastic process our empirical results offer several new insights into the dynamics of exchange rates

on the concavity of the consumption function at least since keynes 1935 many economists have had the intuition that the marginal propensity to consume out of wealth declines as wealth increases nonetheless standard perfect certainty and certainty equivalent versions of intertemporal optimizing models of consumption imply a marginal propensity to consume that is unrelated to the level of household wealth we show that adding income uncertainty to the standard optimization problem induces a concave consumption function in which as keynes suggested the marginal propensity to consume out of wealth or transitory income declines with the level of wealth