international correlation risk we show that the cross sectional dispersion of conditional foreign exchange fx correlation is countercyclical and that currencies that perform badly well during periods of high dispersion yield high low average excess returns we also find a negative cross sectional association between average fx correlations and average option implied fx correlation risk premiums our findings show that while investors in spot currency markets require a positive risk premium for exposure to high dispersion states fx option prices are consistent with investors being compensated for the risk of low dispersion states to address our empirical findings we propose a no arbitrage model that features unspanned fx correlation risk

labor market returns to two and four year college the paper examines labor market returns to a two and four year college education analysis of the 1972 national longitudinal survey of youth observation that the average person who attended a two year college earned about 10 percent more than those without any college education comparison with the wages of those who attended a four year college education

exchange arrangements entering the twenty first century which anchor will hold this article provides a comprehensive history of anchor or reference currencies exchange rate arrangements and a new measure of foreign exchange restrictions for 194 countries and territories over 1946 2016 we find that the often cited post bretton woods transition from fixed to flexible arrangements is overstated regimes with limited flexibility remain in the majority even if central bankers communications jargon has evolved considerably in recent decades it is apparent that many still place a large implicit weight on the exchange rate the u s dollar scores as the world s dominant anchor currency by a very large margin by some metrics its use is far wider today than 70 years ago in contrast the global role of the euro appears to have stalled we argue that in addition to the usual safe assets story the record accumulation of reserves since 2002 may also have to do with many countries desire to stabilize exchange rates in an environment of markedly reduced exchange rate restrictions or more broadly capital controls an important amendment to the conventional portrayal of the macroeconomic trilemma

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

unemployment risk and precautionary wealth evidence from households balance sheets this paper examines precautionary behavior by relating job loss risk to household net worth we use existing best practice and some new strategies to deal with some problematic issues inherent in this literature regarding proxying uncertainty instrumentation and incorporating theoretical restrictions we do not find precautionary variation in the wealth holdings of households with low permanent income but do find precautionary effects for moderate and higher income households when the dependent variable is total net worth these findings are robust to several alternative specifications but we do not find precautionary responses in subaggregates of wealth that exclude home equity

interrupted work careers depreciation and restoration of human capital the quantitative effects and even the existence of a human capital depreciation phenomenon have been a subject of controversy in the recent literature prior work however was largely cross sectional and the longitudinal dimension if any was retrospective using longitudinal panel data on married women in nls we have now established that real wages at reentry are indeed lower than at the point of labor force withdrawal and the decline in wages is greater the longer the interruption another striking finding is a relatively rapid growth in wages after the return to work this rapid growth appears to reflect the restoration or repair of previously eroded human capital the phenomenon of depreciation and restoration is also visible in data for immigrants to the united states however while immigrants eventually catch up with and often surpass natives returnees from the nonmarket do not fully restore their earnings potential

interest rate volatility and the term structure a two factor general equilibrium model we develop a two factor general equilibrium model of the term structure the factors are the short term interest rate and the volatility of the short term interest rate we derive closed form expressions for discount bonds and study the properties of the term structure implied by the model the dependence of yields on volatility allows the model to capture many observed properties of the term structure we also derive closed form expressions for discount bond options we use hansen s generalized method of moments framework to test the cross sectional restrictions imposed by the model the tests support the two factor model there are essentially two approaches to the modeling of the term structure of interest rates in continuous time the equilibrium approach pioneered by

tastes and technology in a two country model of the business cycle explaining international trade on international financial markets allows people to insure country specific risk and smooth consumption intertemporally equilibrium models of business cycles with trade on global financial markets typically yield international consumption correlations near one and excessive volatility of investment the authors incorporate nontraded goods in the model and find that the implications for aggregate consumption investment and the trade balance are consistent with business cycle properties of industrialized countries however the model driven by technology shocks alone yields counterfactual implications for comovements between consumption and prices at the sectoral level taste shocks produce price quantity relationships more consistent with the data copyright 1995 by american economic association

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

the stochastic volatility of short term interest rates some international evidence this paper estimates a stochastic volatility model of short term riskless interest rate dynamics estimated interest rate dynamics are broadly similar across a number of countries and reliable evidence of stochastic volatility is found throughout in contrast to stock returns interest rate volatility exhibits faster meanreverting behavior and innovations in interest rate volatility are negligibly correlated with innovations in interest rates the less persistent behavior of interest rate volatility reflects the fact that interest rate dynamics are impacted by transient economic shocks such as central bank announcements and other macroeconomic news the past decade has witnessed unprecedented growth in the market for fixedincome derivatives domestically as well as internationally in light of this growth recent research has attempted to empirically characterize the dynamics of short term riskless interest rates necessary for the valuation of many of these securities with few exceptions much of this evidence has been concerned with the behavior of u s interest rates the purpose of this paper is to investigate the dynamics of short term interest rates across a number of countries a particularly noteworthy feature at least of the u s evidence is that the volatility of short term interest rates is itself volatile the stochastic nature of volatility is an important property of interest rate dynamics which we wish to focus on in our comparison to do so practically this paper implements a computationally efficient and statistically reliable method for estimating stochastic volatility models in finance we apply this method to chan et al s 1992 specification of short term riskless interest rate dynamics augmented with stochastic volatility for a clean international comparison we use proxies for short term riskless interest rates drawn from the same market the london interbank market over the same sample period unlike nowman 1997 we find that the

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

what is the economic cost of the investment home bias overinvesting domestically is well known as an investment home bias ihb we define an economic home bias ehb whereby the ihb measures the investment weights and the ehb measures the economic cost induced by the ihb we may have a large ihb and a negligible ehb with the increase in the average correlation between foreign markets from 0 4 for the decade ending in 1988 to about 0 9 for more recent decades the u s ehb is becoming negligible despite the domestic investment of 77 5 since 2009 the correlations have decreased indicating that the hb puzzle is emerging once again

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

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

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

international portfolio nondiversification and exchange rate variability abstract incomplete international portfolio diversification is implied by an equilibrium models of exchange rates with nontraded goods the model can also explain the greater correlation between consumption and income within a country than between consumption across countries nontraded goods make more stringent the elasticity conditions required to explain exchange rate variability resulting from current productivity disturbances though not from disturbances to fiscal policies or the prospective return to investment the model is also consistent with international real interest rate differentials changes over time in the current account and relative wealth across nations and observed time series properties of exchange rates

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

evaluating international financial integration in a center periphery economy abstract does opening up capital markets facilitate risk diversification across borders are all countries gradually better off in the process of international financial integration this paper explores welfare implications for various countries in a center periphery framework with endogenous portfolio choice financial integration is divided into four stages financial autarky two country integration center periphery integration and global integration two effects from financial integration emerge diversification effects and financial terms of trade effects results show that financial integration between the center and a new periphery in center periphery integration generates welfare losses for the peripheral country already integrated and welfare gains for the central country allowing for financial integration between peripheries in global integration leads the welfare in the center to deteriorate from two country integration directly to global integration the large country gains while the small one loses

learning by doing and investment in training a synthesis of two rival models of the life cycle this paper provides a theoretical synthesis of recent discussions of learning by doing and investment in training as alternative forms of human capital accumulation these theoretical notions relate to essentially different phenomena in particular pace becker and mincer investment in training does not completely encompass learning by doing the paper then develops a model in which human capital accumulation occurs via both training and learning by doing the joint training learning model since it is more general then pure models in which all accumulation occurs via either training or learning avoids certain restrictive and seemingly implausible implications of either kind of pure model however the joint model also has implications that while compatible with stylized facts about the life cycle are sharper than those of either kind of pure model for example the joint model implies that market time and earnings must rise early in the life cycle while neither pure model without corners does so finally the notion of learning by doing provides a rationale for an empirical finding that has recently received attention to the effect that the rate of depreciation of human capital is not constant but rather depends on the extent to which it is used in market activities

learning by doing vs learning about match quality can we tell them apart understanding the accumulation of match specific capital is crucial in shedding light on the reasons for the prevalence of long term employ ment relationships and on the welfare consequences of turnover in the labor market one of the most important source of match specific capital is human capital acquired through match specific learning such learn ing can take on two distinct forms in the first case workers accumulate match specific human capital through learning by doing in the second case a worker and a firm in an employment relationship learn about the quality of the match over time thereby acquiring valuable information i construct a structural model that embeds these two learning explana tions i show that it is possible to distinguish the two explanations given turnover data on employing firms coupled with data on workers such data now exist in the form of matched employer employee data sets i use a matched french data set to estimate the structural model using the efficient method of moments a simulation based estimation method i find that while learning by doing could be present in the first few months of an employment relationship learning about match quality dominates at tenures above half a year this finding has important consequences for economists understanding of the sources of match specific capital and for the desirability of policies that alter the incentives for turnover for workers of different tenure

early career work experience and gender wage differentials we estimate a wage model that includes an array of variables measuring the fraction of time worked during each year of the career this array fully characterizes past employment experience regardless of how sporadic it has been our model yields substantially higher estimated returns to experience and lower returns to tenure than do models that measure experience cumulatively and use the standard quadratic functional form we find that the data reject the standard model but fail to reject our model furthermore we find that 12 of the male female wage gap is due to differences in the timing of work experience

the effects of state mandated financial education on college financing behaviors students entering college have limited financial experience while making complex borrowing decisions this paper examines a policy lever that may improve these decisions high school personal finance graduation requirements we use a difference in difference strategy to determine their effects on financial aid decisions of incoming freshmen at 4 year institutions our results suggest financial education shifts students from high cost to low cost financing the requirements increase aid applications and acceptance of federal loans while decreasing the likelihood of holding credit card balances students from less affluent family backgrounds reduce their likelihoods of working and borrowers from more affluent backgrounds reduce private loan amounts

the effects of interrupted schooling on wages data from the national longitudinal survey of youth reveal that 35 percent of white men who leave school between 1979 and 1988 return to school by 1989 this paper examines the wage effects of these nontraditional enrollment patterns i estimate a wage model which allows individuals to follow a different wage path before and after their reenrollment and an alternative model which does not account for school and work discontinuities i find that young men who delay their schooling receive wage boosts that are smaller than those received by their continuously schooled counterparts wage models that fail to account for delayed schooling tend to understate the returns to schooling received prior to the start of the career

out of sample performance of discrete time spot interest rate models we provide a comprehensive analysis of the out of sample performance of a wide variety of spot rate models in forecasting the probability density of future interest rates although the most parsimonious models perform best in forecasting the conditional mean of many financial time series we find that the spot rate models that incorporate conditional heteroscedasticity and excess kurtosis or heavy tails have better density forecasts generalized autoregressive conditional heteroscedasticity significantly improves the modeling of the conditional variance and kurtosis whereas regime switching and jumps improve the modeling of the marginal density of interest rates our analysis shows that the sophisticated spot rate models in the existing literature are important for applications involving density forecasts of interest rates

short term interest rates as subordinated diffusions in this article we cbaracterize and estimate the process for short term interest rates using federal funds interest rate data we presume that we are observing a discrete time sample of a stationary scalar diffusion we concentrate on a class of models in whicb the local volatility elasticity is constant and the drift has aflexible specufication to accommodate missing observations and to break the link between economic time and calendar time we model the sampling scheme as an increasing process that is not directly observed we propose and implement two new methods for estimation we find evidence for a volatility elasticity between one and onehalf and two when interest rates are high local mean reversion is smaul and the mechanism for inducing stationarity is the increased volatility of the diffusion process

moving back home insurance against labor market risk this paper demonstrates that the option to move in and out of the parental home is a valuable insurance channel against labor market risk which facilitates the pursuit of jobs with the potential for high earnings growth using monthly panel data i document an empirical relationship among coresidence individual labor market events and subsequent earnings growth i estimate the parameters of a dynamic game between youths and parents to show that the option to live at home can account for features of aggregate data for low skilled young workers small consumption responses to shocks high labor elasticities and low savings rates

a nonlinear general equilibrium model of the term structure of interest rates abstract we derive and test an alternative closed form general equilibrium model of the term structure within the cox ingersoll and ross theoretical framework in which yields are nonlinear functions of the risk free rate we show that equilibrium bond prices and the risk free rate are not always inversely related and that bond risk need not be strictly increasing in maturity using hansen s generalized method of moments to obtain parameter estimates this nonlinear model outperforms the cox ingersoll and ross square root model in describing actual treasury bill yields for the 1964 1986 period

do trade costs in goods market lead to home bias in equities abstract two of the main puzzles in international economics are the consumption and the portfolio home biases we solve for international equity portfolios in a two country two good stochastic equilibrium model with trade costs in goods markets we show that introducing trade costs as suggested by obstfeld and rogoff obstfeld m rogoff k 2000a the six major puzzles in international macroeconomics is there a common cause nber macroeconomics annual 15 is not sufficient to explain these two puzzles simultaneously on the contrary we find that trade costs create a foreign bias in portfolios for reasonable parameter values this result is robust to the addition of non tradable goods for standard calibrations of the preferences

commodity trade and the carry trade a tale of two countries persistent interest rate differentials account for much of the currency carry trade profitability commodity currencies offer high interest rates on average while countries that export finished goods tend to have low interest rates we develop a general equilibrium model of international trade and currency pricing where countries have an advantage in producing either basic inputs or final goods in the model domestic production insulates commodity producing countries from global productivity shocks forcing final good producers to absorb them commodity currency exchange rates and risk premia increase with productivity differentials and trade frictions these predictions are strongly supported in the data this article is protected by copyright all rights reserved

the performance of alternative interest rate risk measures and immunization strategies under a heath jarrow morton framework using a monte carlo simulation this study addresses the question of how traditional risk measures and immunization strategies perform when the term structure evolves in a heath jarrow morton 1992 manner the results suggest that for immunization purposes im munization strategies and portfolio formation strategies are more important than interest rate risk measures the performance of immunization strategies depends more on the transaction costs and the holding period than on the risk measures moreover the immu nization performance of bullet and barbell portfolios is not very sensitive to interest rate risk measures

education policy and intergenerational transfers in equilibrium this paper compares partial and general equilibrium effects of alternative financial aid policies intended to promote college participation we build an overlapping generations life cycle heterogeneous agent incomplete markets model with education labor supply and consumption saving decisions altruistic parents make inter vivos transfers to their children labor supply during college government grants and loans as well as private loans complement parental transfers as sources of funding for college education we find that the current financial aid system in the u s improves welfare and removing it would reduce gdp by two percentage points in the long run any further relaxation of government sponsored loan limits would have no salient effects the short run partial equilibrium effects of expanding tuition grants especially their need based component are sizeable however long run general equilibrium effects are 3 4 times smaller every additional dollar of government grants crowds out 20 30 cents of parental transfers

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

the impact of student debt on education career and marriage choices of female lawyers abstract we develop and estimate a dynamic model to study the impact of student debt on education career and marriage market choices of young female lawyers our model accounts for several important institutional features of the labor market for lawyers including differences in the work hours across occupational tracks and learning about the prospects of promotion to partner some female students need to take on large amounts of student debt to finance their education and hence start their careers with large amounts of negative wealth the empirical findings suggest that student debt has negative effects on marriage prospects career prospects and investments in educational quality of female lawyers the analysis also provides new insights into the design of public policies that aim to increase public sector employment we show that it is possible to design conditional wage or debt service subsidy programs that significantly increase public sector career choices at reasonable costs

an equilibrium model of exchange rate determination and asset pricing with nontraded goods and imperfect information this paper presents a two country model with maximizing households stochastic production stochastic money growth and perfect capital mobility because of the presence of nontraded goods households in different countries consume different goods analytic solutions are presented for the nominal exchange rate the real exchange rate nominal interest rates and real interest rates it is shown that the model is compatible with some important features of the real world behavior of exchange rates when households are imperfectly informed about the distribution of money growth the exchange rate exhibits patterns of overshooting and is more volatile than the ratio of the money stocks copyright 1987 by university of chicago press

a one factor model of interest rates and its application to treasury bond options 1990 a one factor model of interest rates and its application to treasury bond options financial analysts journal vol 46 no 1 pp 33 39

nontraded goods nontraded factors and international non diversification abstract can the presence of nontraded consumption goods or nontraded factors of production explain the high degree of home bias displayed by investor portfolios we find that the answer is no so long as individuals have access to free international trade in financial assets in particular it is never optimal to exhibit home bias with respect to domestic traded good equities by contrast holdings of nontraded good equities in an optimal portfolio will depend sensitively on the elasticity of substitution between traded and nontraded goods

the cyclical properties of consumption growth and the real term structure abstract expected real yields on nominally risk free bonds and expected consumption growth at horizons from one quarter to two years are identified using time series models and their basic properties are examined the principal results are 1 real yields and consumption growth are weakly negatively correlated over the full sample period of 1953 1991 2 excluding the 1979 1985 sub period real yields and consumption growth are strongly positively correlated 3 the cyclical properties of real yields and consumption growth are qualitatively similar in the pre 1979 data and they are consistent with a simple real business cycle model

home bias in open economy financial macroeconomics standard theory would predict that investors hold a well diversified portfolio of equities across the world but despite the process of financial globalization investors still hold a disproportionate share of local equities in their portfolio the equity home bias french and poterba 1991 we review the various explanations of this puzzling phenomenon in the context of recent developments in macroeconomic modelling that have allowed to incorporate sophisticated international portfolio choices in standard two country general equilibrium models we refer to this literature as open economy financial macroeconomics we focus on three broad classes of explanations i hedging motives in frictionless financial markets real exchange rate and non tradable income risk ii asset trade costs in international financial markets such as transaction costs differences in tax treatments between national and foreign assets iii informational frictions and behavioural biases these recent developments raise the need for new portfolio facts beyond the equity home bias and we will present some new evidence on cross border asset holdings across different types of assets equities bonds and bank lending we also present some new micro data on institutional holdings of equity at the fund level these data should inform macroeconomic modelling of the open economy and a growing literature of models of delegated investment

evaluating the econometric evaluations of training programs with experimental data this paper takes the results of an employment and training program thatwas run as a field experiment in which the participants were randomlyassigned into a treatment or a control group and compares these results to the estimates that might have been produced by an econometrician who evaluated the program using the same econometric procedures that have been used in the program evaluation literature this comparison shows that many of these econometric procedures fail toreplicate the experimentally determined results and suggests that researchers should be aware of the potential for specification errorsin other nonexperimental evaluations copyright 1986 by american economic association

do bonds span the fixed income markets theory and evidence for unspanned stochastic volatility most term structure models assume bond markets are complete that is that all fixed income derivatives can be perfectly replicated using solely bonds however we find that in practice swap rates have limited explanatory power for returns on at the money straddles portfolios mainly exposed to volatility risk we term this empirical feature unspanned stochastic volatility usv while usv can be captured within an hjm framework we demonstrate that bivariate models cannot exhibit usv we determine necessary and sufficient conditions for trivariate markov affine systems to exhibit usv for such usv models bonds alone may not be sufficient to identify all parameters rather derivatives are needed

why common factors in international bond returns are not so common this paper analyzes the common factor structure of us german and japanese government bond returns unlike previous studies we formally take into account the presence of country specific factors when estimating common factors we show that the classical approach of running a principal component analysis on a multi country dataset of bond returns captures both local and common influences and therefore tends to pick too many factors we conclude that us bond returns share only one common factor with german and japanese bond returns this single common factor is associated most notably with changes in the level of domestic term structures we show that accounting for country specific factors improves the performance of domestic and international hedging strategies

the pricing of options on default free bonds recent developments in the finance literature dealing with the valuation of contingent claims have been triggered by black and scholes 2 with their valuation of european options on corporate stocks the type of valuation model derived by black and scholes is attractive because it is independent of preferences this independence is possible due to the fact that the contingent claims are usually assumed to be contingent on traded assets or traded state variables for example a european call option is a claim contingent on the value of the corresponding stock to maintain the independence of the claim from preferences however some variables have to be discarded and considered as constants for example the rate of interest which is not a traded state variable is considered a constant in most of the literature see black and scholes 2 merton 11 and ingersoll 9 though this approximation might not cause important discrepancies in the case of corporate liabilities and options on corporate liabilities the effect of such an approximation on the value of default free bonds and options on default free bonds is more important since these liabilities depend only on the rate of interest

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

exploiting the conditional density in estimating the term structure an application to the cox ingersoll and ross model we propose an empirical method that utilizes the conditional density of the state variables to estimate and test a term structure model with known price formulae using data on both discount and coupon bonds the method is applied to an extension of a two factor model due to cox ingersoll and ross 1985 cir our results show that estimates based on only bills imply unreasonably large price errors for longer maturities we reject the original cir model using a likelihood ratio test and conclude that the extended cir model also fails to provide a good description of the treasury market

trade network centrality and currency risk premia i uncover an economic source of exposure to global risk that drives international asset prices countries that are more central in the global trade network have lower interest rates and currency risk premia to explain these findings i present a general equilibrium model in which central countries consumption growth is more exposed to global consumption growth shocks this causes the currencies of central countries to appreciate in bad times resulting in lower interest rates and currency risk premia empirically central countries consumption growth covaries more with world consumption growth further validating the proposed mechanism

changes in the characteristics of american youth implications for adult outcomes we examine changes in the characteristics of american youth between the late 1970s and the late 1990s with a focus on characteristics that matter for labor market success the current generation is more skilled than the previous one blacks and hispanics have gained relative to whites and women have gained relative to men however the skill distribution has widened overall shifts in parental education generate many of the observed changes we also provide speculative estimates suggesting that if recent trends in technology and the supply of human capital continue wage inequality will increase substantially by 2025

a theory of the nominal term structure of interest rates a model of the nominal term structure of interest rates is developed that has a positive and stationary process for the interest rate and delivers closed form expressions for the prices of discount bonds and european options on bonds unlike the one state variable version of the cox ingersoll and ross 1985 model this model even in its one state variable version allows the term premium to change sign as a function of the state and the term to maturity and also allows for shapes of the yield curve that are observed in the u s data but that are disallowed in the cox ingersoll and ross model article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

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

bond and option pricing when short rates are lognormal this article describes a one factor model for bond and option pricing that is based on the short term interest rate and that allows the target rate mean reversion and local volatility to vary deterministically through time for any horizon the distribution of possible short rates is lognormal so the rate neither falls below zero nor reflects off a barrier at zero a model like this allows one to match the yield curve the volatility curve and the cap curve surprisingly adding to future local volatility lowers the volatility curve a conventional binary tree with probabilities of 0 5 but variable time spacing is used to value bonds and options when the inputs are constant the slope of the yield curve starts out positive and ends up negative while its curvature shifts from negative to positive even when mean reversion is zero the volatility curve has a negative slope the differential cap curve rises steeply through the effects of volatility and then falls steeply through the effects of discounting and a falling forward rate used as the strike price

risky higher education and subsidies abstract tertiary education in the u s requires large investments that are risky lumpy and well timed tertiary education is also heavily subsidized our model suggests that despite adverse selection arising from encouraging poorly prepared students to enroll observed collegiate subsidies improve outcomes substantially relative to the fully decentralized case this result occurs because increases in subsidy rates for college education generate reductions in college failure risk without altering mean returns we find that this mechanism is robust and that tertiary subsidy rates well in excess of those observed in the u s can be justified by failure risk alone

a new test of borrowing constraints for education we discuss a simple model in which parents and children make investments in the children s education investments for other purposes and parents can transfer cash to their children we show that for an identifiable set of parent child pairs parents will rationally under invest in their child s education for these parent child pairs additional financial aid will increase educational attainment the model highlights an important feature of higher education finance the expected family contribution efc that is based on income assets and other factors the efc is neither legally guaranteed nor universally offered our model identifies the set of families that are disproportionately likely to not provide their full efc using a common proxy for financial aid we show in data from the health and retirement study that financial aid increases the educational attainment of children whose families are disproportionately likely to under invest in education financial aid has no effect on the educational attainment of children in other families the theory and empirical evidence identifies a set of children who face quantitatively important borrowing constraints for higher education

corrections and additions to a nonlinear equilibrium model of the term structure of interest rates abstract longstaff 1989 introduces a new process for the short rate of interest he claims to derive the zero coupon bond pricing formula and state transition density for his model we demonstrate that longstaff s pricing formula is not the solution to the pricing problem which he poses the source of his error is a failure to properly account for a boundary condition we introduce a new model economy and derive a new endogenous interest rate process and find the green s function and the price of a zero coupon bond for our model economy

the lucas orchard this paper investigates the behavior of asset prices in an endowment economy in which a representative agent with power utility consumes the dividends of multiple assets the assets are lucas trees a collection of lucas trees is a lucas orchard the model generates return correlations that vary endogenously spiking at times of disaster since disasters spread across assets the model generates large risk premia even for assets with stable cashflows very small assets may comove endogenously and hence earn positive risk premia even if their cashflows are independent of the rest of the economy i provide conditions under which the variation in a small asset s price dividend ratio can be attributed almost entirely to variation in its risk premium

the behavior of interest rates implied by the term structure of eurodollar futures this paper considers an equilibrium model of the term structure that is determined by two stochastic factors a short term interest rate and a target level to which the short rate is expected to revert a kalman filter technique that uses a time series cross section of eurodollar futures prices is developed to estimate the parameters of the model the term structures of spot libor and eurodollar futures volatility are compared to that predicted by the model the empirical results indicate that the two factor specification represents a significant improvement over its one factor version copyright 1996 by ohio state university press

sovereign debt portfolios bond risks and the credibility of monetary policy we document that governments whose local currency debt provides them with greater hedging benefits actually borrow more in foreign currency we introduce two features into a government s debt portfolio choice problem to explain this finding risk averse lenders and lack of monetary policy commitment a government without commitment chooses excessively countercyclical inflation ex post which leads risk averse lenders to require a risk premium ex ante this makes local currency debt too expensive from the government s perspective and thereby discourages the government from borrowing in its own currency

dynamic models of the term structure in the past 25 years tremendous progress has been made in modeling the dynamics of the term structure of interest rates which play an instrumental role in determining prices and hedging portfolios of fixed income derivative securities this article reviews the theoretical development of the dynamic models of the default free term structure and their applications in pricing interest rate options classic models sometimes termed equilibrium models and their multifactor extensions are outlined these models provide clear economic intuitions connecting the term structure with economic fundamentals they also lay a foundation for the framework of the arbitrage models that price interest rate derivatives on the basis of the market prices of bonds this framework has been expanded and enriched by recent advances in directly modeling observable market rates through the market models and in incorporating an internally consistent correlation structure through the infinite dimensional models

term structure factor shifts and economic news for this article daily changes in pure discount yields on u s risk free securities were fit to a theoretically robust term structure model to derive a set of orthogonal factors measuring the level slope and curvature of the yield curve changes in these factors at the release of unexpected economic news are reported this methodology explicitly allows for commonalities in responses in the universe of spot rates thus painting a rich picture of interest rate reactions to new information the results have important implications for hedging volatility risk or seeking to profit from predicting volatility in bond prices

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

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

recent advances in estimating term structure models in the past 10 years increasingly sophisticated statistical techniques have been applied to the estimation of increasingly complex models of the term structure of interest rates in reviewing this literature we highlight the facts that have been established and the key unresolved issues the data indicate that within a wide range of interest rates mean reversion in rates is at best weak whether mean reversion is stronger for very high or very low levels of rates is an unresolved issue the absolute volatility of rates increases as the level of rates increases but the strength of this effect and the role and nature of either stochastic volatility or regime switching components in rates are still unclear unfortunately these unresolved issues have important implications for fixed income option pricing and risk measurement including value at risk calculations

mismatch in human capital accumulation this article studies the allocation of heterogeneous agents to levels of educational attainment the goal is to understand the magnitudes and sources of mismatch in this assignment both in theory and in the data the article presents evidence of substantial mismatch between ability and educational attainment across 21 oecd countries with a main focus on germany italy japan and the united states model parameters are estimated using a simulated method of moments approach the main empirical finding is that measured mismatch arises largely from noise in test scores and does not reflect borrowing constraints taste shocks play a minor role in explaining mismatch

a markov model of switching regime arch in this article i present a new approach to model more realistically the variability of financial time series i develop a markov arch model that incorporates the features of both hamilton s switching regime model and engle s autoregressive conditional heteroscedasticity arch model to examine the issue of volatility persistence in the monthly excess returns of the three month treasury bill the issue can be resolved by taking into account occasional shifts in the asymptotic variance of the markov arch process that cause the spurious persistence of the volatility process i identify two periods during which there is a regime shift the 1974 2 1974 8 period associated with the oil shock and the 1979 9 1982 8 period associated with the federal reserve s policy change the variance approached asymptotically in these two episodes is more than 10 times as high as the asymptotic variance for the remainder of the sample i conclude that regime shifts have a greater impact on the properties of the data and i ca

decomposing trends in inequality in earnings into forecastable and uncertain components a substantial empirical literature documents the rise in wage inequality in the american economy it is silent on whether the increase in inequality is due to components of earnings that are predictable by agents or whether it is due to greater uncertainty facing them these two sources of variability have different consequences for both aggregate and individual welfare using data on two cohorts of american males we find that a large component of the rise in inequality for less skilled workers is due to uncertainty for skilled workers the rise is less pronounced

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

general equilibrium real and nominal interest rates we derive the general equilibrium short term real and nominal interest rates in a monetary economy affected by technological and monetary shocks and where the price level dynamics is endogenous assuming fairly general processes for technology and money supply we show that an inherent feature of our equilibrium is that any real variable dynamics in particular that of the short term real interest rate is driven by both monetary and real factors this money non neutrality is generic as it does not stem from any friction such as price stickiness or from a particular utility function non neutrality obtains because the ex ante cost of real money holdings is random due to inflation uncertainty we then analyze in depth a specialized version of this economy in which the state variables follow square root processes and the representative investor has a log separable utility function the short term nominal rate dynamics we obtain encompasses most of the dynamics present in the literature from vasicek and cir to recent quadratic and more generally non linear interest rate models moreover our results pave the way to several new nominal term structures

testing for educational credit constraints using heterogeneity in individual time preferences i develop a model in which individual time discount rates have a larger effect on human capital accumulation when credit constraints are binding impatient individuals obtain less schooling when borrowing constraints limit the ability to finance consumption during school using data from the nlsy79 i show that self reported measures of time preferences have a significantly higher effect on the college attendance decisions of blacks than those of whites and the decisions of low income youths than those of high income youths these results provide new evidence that members of disadvantaged groups obtain lower levels of schooling because they are credit constrained

explorations into factors explaining money market returns in this article we measure and interpret the common factors that describe money market returns results are presented for both three and four factor models we find that the three factor model explains on average 86 percent of the total variation in most money market returns while the four factor model explains on average 90 percent of this variation using mimicking portfolios we provide an interpretation of the systematic risks represented by these factors in this article we attempt to measure and interpret the common factors that describe money market returns the factor approach we employ assumes that the covariance matrix of a set of random variables in this case excess returns can be decomposed into common or systematic components and idiosyncratic or nonsystematic components this decomposition into systematic and nonsystematic components is based on an assumption of a linear relationship between the returns of each security and a set of common factors this is the assumption of linear return generating models which form an integral part of the structure of many asset pricing theories for example arbitrage pricing theory apt as developed by ross 1976 the interpretation is that the common factors represent sources of systematic or nondiversifiable risk and the idiosyncratic component of returns represents diversifiable risks our focus here is not on testing a particular asset pricing model per se but on developing empirical evidence for the existence of stylized facts regarding money market returns the stylized facts take the form of the existence measurement and interpretation of the common factors that are found in money markets our attempt to measure and interpret these sources of systematic risk may eventually lead to the construction of observable eco

another look at models of the short term interest rate the short term rate of interest is fundamental to much of theoretical and empirical finance yet no consensus has emerged on the dynamics of its volatility we show that models which parameterize volatility only as a function of interest rate levels tend to over emphasize the sensitivity of volatility to levels and fail to model adequately the serial correlation in condi tional variances on the other hand serial correlation based models like garch models fail to capture adequately the relationship between interest rate levels and volatility we introduce and test a new class of models for the dynamics of short term interest rate volatility which allows volatility to depend on both interest rate levels and information shocks two important conclusions emerge first the sensitivity of interest rate volatility to interest rate levels has been overstated in the literature while this relationship is important adequately modeling volatility as a function of unexpected information shocks is also important sec ond we conclude that the volatility processes in many existing theoretical models of interest rates are misspecified and suggest new paths toward improving the theory

the effect of credit constraints on the college drop out decision a direct approach using a new panel study a serious difficulty in determining the importance of credit constraints in education arises because standard data sources do not provide a direct way of identifying which students are credit constrained this paper differentiates itself from previous work by taking a direct approach made possible by unique longitudinal data from the berea panel study the results from our study of berea college students suggest that while credit constraints likely play an important role in the drop out decisions of some students the large majority of attrition of students from low income families should be primarily attributed to reasons other than credit constraints jel i21 i22

good carry bad carry we distinguish between good and bad carry trades constructed from group of ten g 10 currencies the good trades exhibit higher sharpe ratios and sometimes positive return skewness in contrast to the bad trades which have both substantially lower sharpe ratios and highly negative return skewness surprisingly good trades do not involve the most typical carry currencies like the australian dollar and japanese yen the distinction between good and bad carry trades significantly alters our understanding of currency carry trade returns and invalidates for example explanations invoking return skewness and crash risk

borrowing constraints college enrollment and delayed entry in this article i propose and estimate a dynamic model of education borrowing and work decisions of high school graduates i examine the effect of relaxing borrowing constraints on educational attainment by simulating increases in the amount students are permitted to borrow from government sponsored loan programs my results indicate that borrowing constraints have a small impact on attainment the removal of education related borrowing constraints raises bachelor s degree completion by 2 4 percentage points tuition subsidies are necessary to obtain larger increases i find that higher subsidies for average ability students are the most cost effective targeted tuition subsidies

the term structure of interest rates in real and monetary economies abstract this paper modifies standard asset pricing models by introducing capital a variable labor supply and money a surprising but very positive result is that in a real production economy the interest rate is close to a random walk this result is found to be true even if there is no persistence in the driving process of the model in this paper we generalize the standard cash in advance constraint by using a shopping time technology this generalization makes it possible to match observed variability for the velocity of money this type of monetary model however is not successful in matching observed behavior of bond prices

pricing interest rate derivative securities this article shows that the one state variableinterest rate models of vasicek 1977 and cox ingersoll and ross 1985b can be extended sothat they are consistent with both the current termstructure of interest rates and either the currentvolatilities of all spot interest rates or the currentvolatilities of all forward interest rates theextended vasicek model is shown to be very tracta ble analytically the article compares option pricesobtained using the extended vasicek model withthose obtained using a number of other models