money and capital abstract the effects of money anticipated inflation on capital formation is a classic issue in macroeconomics previous papers adopt reduced form approaches putting money in the utility function or imposing cash in advance but using otherwise frictionless models we follow instead a literature that tries to be explicit about the frictions making money essential this introduces new elements including a two sector structure with centralized and decentralized markets stochastic trading opportunities and bargaining these elements matter quantitatively and numerical results differ from findings in the reduced form literature the analysis also reduces a gap between microfounded monetary economics and mainstream macro

50th anniversary article option pricing valuation models and applications this paper surveys the literature on option pricing from its origins to the present an extensive review of valuation methods for european and american style claims is provided applications to complex securities and numerical methods are surveyed emphasis is placed on recent trends and developments in methodology and modeling

an equilibrium model of the business cycle with household production and fiscal policy the authors estimate a dynamic general equilibrium model of the u s economy that includes an explicit household production sector and stochastic fiscal variables they use their estimates to investigate two issues first the authors analyze how well the model accounts for aggregate fluctuations they find that household production has a significant impact and reject a nested specification in which changes in the home production technology do not matter for market variables second the authors study the effects of some simple fiscal policy experiments and show that the model generates different predictions for the effects of tax changes than similar models without home production copyright 1997 by economics department of the university of pennsylvania and the osaka university institute of social and economic research association

empirical martingale simulation for asset prices this paper proposes a simple modification to the standard monte carlo simulation procedure for computing the prices of derivative securities the modification imposes the martingale property on the simulated sample paths of the underlying asset price this procedure is referred to as the empirical martingale simulation ems the ems ensures that the price estimated by simulation satisfies the rational option pricing bounds the ems yields a substantial error reduction for the price estimate and can be easily coupled with the standard variance reduction methods simulation studies are conducted for european and asian call options using both the black and scholes and garch option pricing frameworks the results indicate that the ems yields substantial variance reduction particularly for in and at the money or longer maturity options the option price estimate based on the ems is found to exhibit a minor small sample bias only in few occasions an analysis of the trade off between computing time and price accuracy reveals that the ems dominates the conventional simulation methods

pricing european average rate currency options abstract this paper develops a simple methodology that yields closed form analytical approximations for valuing european option claims involving the arithmetic average of future foreign exchange rates the main advantage of the approach is that it avoids the need to adopt time consuming numerical procedures the precision of the resulting formula and the distributional assumption that underlies it is examined by way of monte carlo simulations jel f31

international business cycles and financial frictions abstract in this study i build a two country dsge model to investigate the impact of financial integration on business cycle co movements with financial frictions in this model the investor can borrow but faces a collateral constraint that is tied to the value of her capital and real estate holdings i show quantitatively that the degree of financial integration and real exchange rate adjustment are important for understanding business cycle synchronization under different types of shocks with the technology shock greater financial integration leads to lower cross country correlations while with the financial shock greater financial integration leads to stronger cross country correlations these findings are consistent with the empirical evidence from the literature

electoral uncertainty fiscal policy and macroeconomic fluctuations abstract in this paper we study the link between elections fiscal policy and aggregate fluctuations the setup is a stylized dynamic stochastic general equilibrium model incorporating both technology and political re election shocks the latter are incorporated via a two party model with elections the main theoretical prediction is that forward looking incumbents with uncertain prospects of re election find it optimal to follow relatively shortsighted fiscal policies and that this hurts capital accumulation our econometric estimation using u s data finds a statistically significant link between electoral uncertainty and policy instruments and in turn macroeconomic outcomes

a pricing method for options based on average asset values abstract in this paper we present a new strategy for pricing average value options i e options whose payoff depends on the average price of the underlying asset over a fixed period leading up to the maturity date such options are of particular interest and importance for thinly traded assets e g crude oil since price manipulation is inhibited and both the investor and issuer enjoy a welcome degree of protection from the vagaries of the market these options are often implicit in a bond contract although they also appear in a straightforward form our results suggest that the price of an average value option will always be lower than that of a standard european option our pricing strategy involves monte carlo simulation with variance reduction elements and offers an enhanced pricing method to both arbitragers and hedgers as well as to the issuers of such bonds

a dynamic programming procedure for pricing american style asian options pricing european style asian options based on the arithmetic average under the black and scholes model involves estimating an integral a mathematical expectation for which no easily computable analytical solution is available pricing their american style counterparts which provide early exercise opportunities poses the additional difficulty of solving a dynamic optimization problem to determine the optimal exercise strategy a procedure for pricing american style asian options of the bermudan flavor based on dynamic programming combined with finite element piecewise polynomial approximation of the value function is developed here a convergence proof is provided numerical experiments illustrate the consistency and efficiency of the procedure theoretical properties of the value function and of the optimal exercise strategy are also established

time allocation and home production technology abstract this paper studies the effect of the relative productivity between the market sector and the home sector on time allocation a novelty of the paper is to jointly estimate home productivity and the elasticity of substitution between market goods and home hours which is accomplished through structural estimation based on income decile level data with a high elasticity of substitution and a slower growth rate of productivity in the home sector relative to the market sector the model can produce key data patterns of time allocation in both the cross sections and time series quantitatively relative productivity can account for 32 of the variation in market hours and 18 of the variation in home hours

pricing options under generalized garch and stochastic volatility processes in this paper we develop an efficient lattice algorithm to price european and american options under discrete time garch processes we show that this algorithm is easily extended to price options under generalized garch processes with many of the existing stochastic volatility bivariate diffusion models appearing as limiting cases we establish one unifying algorithm that can price options under almost all existing garch specifications as well as under a large family of bivariate diffusions in which volatility follows its own perhaps correlated process through an equilibrium argument duan 1995 shows that options can be priced when the dynamics for the price of the underlying instrument follows a general autoregressive conditionally heteroskedastic garch process the theory of pricing under such processes is now well understood however the design of efficient numerical procedures for pricing them is lacking most applications resort to large sample simulation methods with a variety of variance reduction techniques the complexity of pricing arises from the massive path dependence inherent in garch models this path dependence causes typical lattice based procedures to grow exponentially in the number of time increments the lack of efficient numerical schemes hinders empirical tests among the wide array of competing garch models most tests of garch models limit themselves to the use of high frequency data on spot assets with little attention placed on the information content of options 1

by force of demand explaining cyclical fluctuations of international trade and government spending abstract this paper explores the role of demand shocks as an alternative to productivity shocks in driving both domestic and international business cycles within the international real business cycle irbc framework in addition to those well documented domestic business cycle fluctuations e g the volatility and cyclicality of output consumption investment labor hours and labor productivity and international business cycle properties e g the countercyclical net export and the comovement puzzle this paper focuses on two additional stylized facts in the industrialized countries the procyclical trade openness the gdp fraction of trade volume and the countercyclical government size the gdp fraction of government spending using a parsimonious dynamic stochastic general equilibrium model we show that the model s predictions under productivity shocks are not consistent with these facts instead a demand shock driven model replicates the above facts while matching other domestic and international business cycle properties an estimated version of the model confirms the quantitatively important impacts of demand shocks

household production and the excess sensitivity of consumption to current income empirical research on the permanent income hypothesis pih has found that consumption growth is excessively sensitive to predictable changes in income this finding is interpreted as strong evidence against the pih we propose an explanation for apparent excess sensitivity that is based on a quantitative equilibrium model of household production in which permanent income consumers respond to shifts in sectoral wages and prices by substituting work effort and consumption across home and market sectors although the pih is true this mechanism generates apparent excess sensitivity because market consumption responds to predictable income growth

labor and investment frictions in a real business cycle model abstract this paper develops a prototype real business cycle model in which labor and investment frictions may compete directly with technology shocks in accounting for fluctuations in the postwar us economy using ireland s 2004a a method for taking models to the data journal of economic dynamics and control 28 1205 1226 methodology we establish that both types of friction are quantitatively important technology shocks still explain a substantial fraction of the fluctuations in aggregate output as the baseline real business cycle model predicts formal hypothesis tests suggest that changes in the recurrence of shocks frictions and structural parameters all play a role in accounting for the shift in the time series properties of the data between the periods before and after 1980

extending quadrature methods to value multi asset and complex path dependent options abstract the exposition of the quadrature quad method andricopoulos widdicks duck and newton 2003 universal option valuation using quadrature methods journal of financial economics 67 447 471 see also corrigendum journal of financial economics 73 603 2004 is significantly extended to cover notably more complex and difficult problems in option valuations involving one or more underlyings trials comparing several techniques in the literature adapted from standard lattice grid and monte carlo methods to tackle particular types of problem show that quad offers far greater flexibility superior convergence and hence increased accuracy and considerably reduced computational times the speed advantage of quad means that even under the curse of dimensionality it is not necessary to resort to monte carlo methods certainly for options involving up to five underlying assets given the universality and flexibility of the method it should be the method of choice for pricing options involving multiple underlying assets in the presence of many features such as early exercise or path dependency

the valuation of path dependent contracts on the average this article values option contracts based on the average price realized over a finite time horizon such contracts are of importance to traders who periodically transact in spot markets and who require protection from adverse moves in their total accrued costs realized over their trading horizons explicit valuation models for pricing a variety of path dependent contracts based on geometric and arithmetic averages are developed the early exercise features of american contracts are investigated and it is shown that this feature has significant value

health at birth parental investments and academic outcomes this paper explores the relationship among health at birth academic outcomes and the potential role of parental investments using administrative panel data from chile using detailed data on pare

understanding the persistence properties of international macroeconomic aggregates in this paper the ability of a two country model of growth and cycles is evaluated to explain the persistence properties of output and consumption across countries simulated output and consumption levels replicate the observed appearance of noncointegration across countries simulated output growth rates however do not explain the observed positive serial correlation of output growth rates the reallocation of resources in response to technology shocks generates a negative serial correlation for output growth rates

pricing a class of american and european path dependent securities path dependent securities depend on current and past values of underlying state variables consequently the usual backward evaluation technique is difficult to apply since state variable values existing earlier in real time are unknown this paper develops a series of propositions which makes possible the pricing of a certain class of both american and european versions of these path dependent securities

growth effects of shifting from a graduated rate tax system to a flat tax i introduction recently the debate concerning fundamental u s tax reform has led to a number of proposals that involve a shift toward a consumption based system 1 one such proposal is the so called flat tax of hall and rabushka 1995 the flat tax would apply a single tax rate to all labor income above a given threshold and to all capital income after fully expensing investment expenditures hall and rabushka 1995 argue that the adoption of their proposal would provide an enormous boost to the u s economy by dramatically improving incentives to engage in productive activities and would save taxpayers hundreds of billions of dollars in compliance and administration costs 2 in this article we develop a quantitative general equilibrium model to assess the growth effects of adopting a flat tax plan similar to the one proposed by hall and rabushka 1995 the model captures many of the features of the current u s tax code such as graduated personal tax rates a standard personal deduction separate tax rates applied to personal and business income double taxation of business income and differential tax treatment of physical and human capital under appropriate parameter settings the model can exhibit either endogenous or exogenous long run growth our choice of functional forms facilitates a closed form solution to the model this allows us to characterize explicitly the economy s transition path following the reform a central issue in the debate over fundamental tax reform is the effect that such a reform would have on economic growth the present analysis builds on the work of stokey and rebelo 1995 who use an endogenous growth framework to identify the key model features and parameters that are important for determining the quantitative impacts of distortionary taxes on long run growth 3 our study differs from theirs and the bulk of the dynamic tax literature in one fundamental respect here we evaluate the growth effects of shifting from a graduatedrate tax system to a flat rate system stokey and rebelo 1995 consider only flat rate systems in which the marginal tax rate is equal to the average tax rate we approximate the graduated rate tax system in the u s economy by an empirical tax rate function that allows the personal tax rate to depend positively on household taxable income in equilibrium household decisions are influenced by both the level and slope of the tax schedule to implement the flat tax reform we shift the parameters of the tax rate function to flatten the marginal tax schedule while maintaining revenue neutrality our methodology treats the hall rabushka proposal as one that in effect moves a representative household from one tax rate schedule to another we view this setup as a reasonable approximation to gauge the growth effects of tax reform at the macro level a more elaborate setup would of course allow for household heterogeneity at a given point in time in this regard we note that caucutt et al 2003 have recently examined the growth effects of graduated rate taxes in a two period overlapping generations model that includes both skilled and unskilled agents in their model a flatter tax schedule increases the fraction of skilled agents in the economy the share of total output devoted to education rises accordingly and the economy s long run growth rate is observed to increase the quantitative implications of their model are difficult to compare to ours however because their two period framework implies a very long time horizon between household decisions about 30 years moreover their model abstracts from many of the features of the u s tax code that we include here in addition to examining the consequences of flattening the marginal tax schedule we investigate the growth effects attributable to other parts of the flat tax proposal such as allowing full investment expensing eliminating the double taxation of business income and increasing the standard personal deduction

lattice models for pricing american interest rate claims this article establishes efficient lattice algorithms for pricing american interest sensitive claims in the heath jarrow and morton paradigm under the assumption that the volatility structure of forward rates is restricted to a class that permits a markovian representation of the term structure the class of volatilities that permits this representation is quite large and imposes no severe restrictions on the structure for the spot rate volatility the algorithm exploits the markovian property of the term structure and permits the efficient computation of all types of interest rate claims specific examples are provided

jump processes in commodity futures prices and options pricing empirical evidence shows that log return relatives on commodity futures prices are not normally distributed this departure from normality seems to be caused by large price changes occurring in the commodity markets with the arrival of important new information this suggests that a jump diffusion model may be a plausible choice for modeling the stochastic process underlying commodity option prices merton 1976a develops a jump diffusion option pricing model assuming that jump risk is unsystematic however the jump diffusion model developed by bates 1991 is more appropriate for commodity option pricing since it allows jump risk to be systematic in this article recent transactions data on futures and futures options are used to test out of sample options using american versions of black s diffusion and bates s jump diffusion models the results show that bates s model performs considerably better than black s model jump diffusion asian option prices are also shown to differ considerably from geometric brownian motion asian option prices

optimal taxation in a growth model with public consumption and home production in a neoclassical growth model with public consumption we show the following pareto optimal tax rules the government should tax leisure and private consumption at the same rate and subsidize net investment at the same rate it taxes net capital income also it should tax capital income more heavily than labor income in an extension for home production the additional rule is to tax investment for home production at the same rate of the tax on private market consumption these tax and subsidy rates should be constant over time except the initial tax rate on capital income

path dependent options extending the monte carlo simulation approach monte carlo simulation has been used to value options since boyle s seminal paper monte carlo simulation however has not been used to its fullest extent for option valuation because of the belief that the method is not feasible for american style options this paper demonstrates how to incorporate optimal early exercise in the monte carlo method of valuing options by linking forward moving simulation and the backward moving recursion of dynamic programming through an iterative search process to demonstrate the potential of this method we use it to value american style options on the average price or asian options the computational experience reveals a flexible valuation technique with potential for application to a range of securities and financial decision problems

household borrowing constraints and residential investment dynamics abstract it is well known that residential investment leads output in the us economy the main contribution of our paper is to highlight the role of household borrowing constraints in accounting for this fact we study the role of home equity loans used to boost consumption as a channel that affects residential investment we consider a multi agent model where some home owning households face borrowing constraints that reflect home equity loans or refinancing constraints we show that the severity of the households borrowing constraints in an economy can generate this stylized fact of us residential investment dynamics interestingly the model correctly predicts coincident residential investment dynamics in countries with less severe borrowing constraints this prediction is borne out when the model is calibrated to french data

optimal taxation with home production abstract optimal taxes for europe and the u s are derived in a realistically calibrated model in which agents buy consumption goods and services and use home capital and labor to produce household services the optimal tax rate on services is substantially lower than the tax rate on goods specifically the planner cannot tax home production directly and instead lowers the tax rate on market services to increase the relative price of home production the optimal tax rate on the return to home capital is strictly positive and the welfare gains from switching to optimal taxes are large