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Monetary cycles, financial cycles, and the business cycle
One of the most robust stylized facts in macroeconomics is the forecasting power of the term spread for future real activity. The economic rationale for this forecasting power usually appeals to expectations of future interest rates, which affect the slope of the term structure. In this paper, we propose a possible causal mechanism for the forecasting power of the term spread, deriving from the balance sheet management of financial intermediaries. When monetary tightening is associated with a flattening of the term spread, it reduces net interest margin, which in turn makes lending less ...
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Generalized canonical regression
This paper introduces a generalized approach to canonical regression, in which a set of jointly dependent variables enters the left-hand side of the equation as a linear combination, formally like the linear combination of regressors in the right-hand side of the equation. Natural applications occur when the dependent variable is the sum of components that may optimally receive unequal weights or in time series models in which the appropriate timing of the dependent variable is not known a priori. The paper derives a quasi-maximum likelihood estimator as well as its asymptotic distribution ...
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Taylor, Black and Scholes: series approximations and risk management pitfalls
Risk managers make frequent use of finite Taylor approximations to option pricing formulas, particularly of first and second order (delta and gamma). This paper shows that for a plausible range of parameter values, the Taylor series for the Black-Scholes formula diverges. Using a numerical technique developed in the paper, it is also shown that even when the series converges, finite approximations of very large order are generally necessary to achieve acceptable levels of accuracy. Implications for risk management and stress testing are discussed.
Journal Article
The yield curve as a predictor of U.S. recessions
The yield curve--specifically, the spread between the interest rates on the ten-year Treasury note and the three-month Treasury bill--is a valuable forecasting tool. It is simple to use and significantly outperforms other financial and macroeconomic indicators in predicting recessions two to six quarters ahead.
Journal Article
The price risk of options positions: measurement and capital requirements
This article evaluates supervisory approaches to the measurement and capital treatment of the price risk of options positions. The authors find that approximate value-at-risk rules tend to provide better estimates of potential losses than simple strategy-based rules. The value-at-risk rules are particularly effective when they adjust for nonlinear changes in options prices. The authors also consider the reporting burdens posed by the different approaches and the consistency of the rules with existing and proposed supervisory frameworks.
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Monetary tightening cycles and the predictability of economic activity
Eleven of fourteen monetary tightening cycles since 1955 were followed by increases in unemployment; three were not. The term spread at the end of these cycles discriminates almost perfectly between subsequent outcomes, but levels of nominal or real interest rates, as well as other interest rate spreads, generally do not.
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A new measure of fit for equations with dichotomous dependent variables
The econometrics literature contains many alternative measures of goodness of fit, roughly analogous to R2, for use with equations with dichotomous dependent variables. There is, however, no consensus as to the measures' relative merits or about which ones should be reported in empirical work. This paper proposes a new measure that possesses several useful properties that the other measures lack. The new measure may be interpreted intuitively in a similar way to R2 in the linear regression context.